What Is a Suspensory Loan?

For those unfamiliar with the lending industry or public finance, it's often difficult to make sense of the myriad of loan contracts available. This article will help readers better understand the class of lending instruments known as "Suspensory Loans."

Definition

A "Suspensory Loan" is a loan whose monthly re-payment schedule, instead of starting immediately, is deferred or "suspended" until some pre-set date in the future.

Who Provides These Loans?

Generally, the government. Because these loans tie up cash for long periods of times and are given to applicants considered too risky for most private banks, it takes the resources of a massive, deeply solvent institution. That said, some private institutions, mainly involved in student loans, have stepped up to become major issuers of suspensory loans.

In The Private Sector

Student loans for college are a good example of suspensory loans. Even though interest accrues from the very start, the repayment schedule for these loans does not begin until a few months after graduation. If student loans worked like mortgages, the student would have to begin repaying them before he has even taken his first midterm. The Catch-22 is that, to avoid defaulting, the student would have to take on a part- or full-time job during college, even though the point of getting an advanced degree would be to improve your job prospects in the first place.

In The Public Sector: Home Ownership For Low-Income Families

Local, state or federal governments can use suspensory loans to encourage home ownership for low-income families or stimulate privately-owned infrastructure improvements. When a family takes out a mortgage, the monthly payments are a combination of the "capital" (amount the loan was for) and the interest on the capital. So, if it's a fixed-rate, 15-year mortgage, the bank would take the capital, multiply the fixed interest rate by the 15-year time frame to calculate the total interest for the loan. The monthly payments on the loan, therefore, would be capital plus interest divided by 180 months. Given the weekly earnings of low income families, this monthly payment would be impossible to meet and they would be denied the mortgage.
In this case, the government could issue a suspensory loan to pay interest owed to the bank, immediately and in-full. As a result, the monthly mortgage payments would be reduced to total capital divided by 180 months. Even though additional interest would accrue on the suspensory loan, the homeowner wouldn't have to start paying that back until years later.

In The Public Sector: Farm Irrigation Systems

Another example of public sector suspensory loans could be the government trying to help struggling farmers pay for the construction of sophisticated irrigation systems for their land. Given the time it takes to find contractors, build the systems, prepare the land, grow the crops, harvest them and institute a new system of field rotation, it could be years before these farms realized the increased output/revenue to meet a monthly repayment schedule.

Risks/Challenges

In the interest of neutrality, it is necessary to point out that suspensory loans are issued with the best of intentions, possess greater accountability than pure government subsidies, support the private sector without commandeering it and create opportunities (e.g., better irrigated farm land, better educated workforce) that contribute to society at large.
However, in the realm of "real politik," suspensory loans can be a way to make lawmakers' pet projects look better on the government's balance sheet, which can have far-reaching consequences (bond ratings, etc.) Also, these loans tie up public money for longer periods. If essential projects arise during these long time periods, the government may be forced to sell bonds, the monthly payment of which further reduces available funds. Finally, due to the suspended payment schedule, the real value of the interest from these loans may be eroded by inflation.