In the Shemittah year, all personal loans are canceled. Accordingly, once Shemittah rolls around, a person may not go and demand payment for a prior loan. Instead, the lender must simply write it off.
Personal loans are voided at the end of the Shemittah year, as it enters Rosh Hashana of the first year of the next cycle. This is because the Torah says it happens at the end of seven years (Deuteronomy 15:1). Only personal loans get canceled by the Shemittah year; this will not clear one’s bar tab or money you owe the contractor who re-did your kitchen. If a person lends someone money for ten years, the intervening Shemittah does not cancel that loan since it has not yet come due. However, if someone says, “I lend you this money on the condition that Shemittah will not cancel the debt,” his condition is not effective. (One cannot stipulate something counter to the Torah’s laws.)
Since only personal loans are wiped clean, if a person turns his debts over to be collected by a beis din before the Shemittah cancels them, then they remain in effect. This is because the Torah specifies loans with “your brother” – that is, between two individuals, not with an organization or a corporation. Many people perceive this to be a kind of “loophole” to get out of doing what the Torah says but it’s actually a very important halacha. The Talmud in Gittin (37a), stresses this law in the case of orphans for whom beis din acts as guardian – or would you rather see orphans starve?
The basis underlying this mitzvah is to elevate us morally. Being able to let go of these debts cultivates the trait of generosity within us. Furthermore, we recognize that all of our wealth comes from God and that He is using the Sabbatical cycle to redistribute it a little, as is His prerogative. If we accept that we can’t ask for something we gave our friend to be repaid, it would certainly never occur to us to deprive others of something that was rightfully theirs to begin with, such as through theft.
Biblically, this mitzvah applies when the Yoveil is observed; rabbinically, it applies in all times and places. In the Mishna, it is discussed in the tenth chapter of tractate Sheviis; in the Talmud, in tractate Gittin (36a-37b) and in Makkos (3a-b). It is codified in the Shulchan Aruch in Choshen Mishpat 67. This mitzvah is #230 of the 365 negative mitzvos in the Rambam’s Sefer HaMitzvos and #57 of the 194 negative mitzvos that can be observed today as listed in the Sefer HaMitzvos HaKatzar of the Chofetz Chaim.