Usury is the charging of excessive interest for a loan and, depending on the jurisdictions, such actions may lead from penalties in a contract to even criminal charges being brought. What is “too much interest” has been a matter long argued about and litigated and now is reduced to statute in the state of California.
Even in the Bible one finds proscription of charging “too much” for loans and while such restrictions are not part of the Ten Commandments, it is perhaps noteworthy that it was money lenders that Jesus is said to have chased from the Temple.
As a practical matter, it may be wondered why there are such restrictions. One can sell one’s home for whatever price the market will allow and the free market is the rule rather than the exception for almost all economic transactions in the United States. Why can one not charge whatever the market will bear for access to one’s money by way of a loan? Somehow, that particular transaction involving the loaning of money has resulted in restrictions being imposed that are unique in the world of commerce.
Perhaps the answer is found in the fact that most people are borrowers rather than lenders and the enslavement of debtors or incarceration of debtors was a common practice from the time of the ancient Greeks up to the founding of the United States. Indeed, one should note that debtor’s prison was a typical English tradition which was prohibited in the United States Constitution and one of the reasons why bankruptcy was specifically allowed in the United States Constitution.
Be that as it may, usury laws are common throughout the United States but in many cases have been evaded and overcome by various powerful interests who wish not to be restricted in the amount of interest that can be charged. In California we have the odd situation that professional lenders such as banks are not prohibited from charging high interest but individuals who may be loaning money to a family member are!
This article shall outline the basics of the California Usury laws and the exceptions to it often encountered by the business person and consumer in California.
The Basic Law:
In California, usury is the charging of interest in excess of that allowed by law. As stated above, due to the machinations of various entities seeking to protect their interests, the usury laws are complicated and there are many exceptions to the general rules. Listed below are some of those general rules. Since there are exceptions, and the penalties for violating usury laws are severe, individuals making loans for which there are interest charges should contact an attorney for further guidance.
a. The Basic Rate: The California Constitution allows parties to contract for interest on a loan primarily for personal, family or household purposes at a rate not exceeding 10% per year. Note that as with all other percentages we are listing, this percentage is based on the unpaid balance. For example, if a loan of $1,000 is to be paid at the end of one year and there are no payments during the year, the lender could charge $100 (10%) as interest. However, if payments are to be made during the year, the maximum charge allowed could be much less since the outstanding balance would have been reduced. For example, if half was paid, then the ten percent due on the remaining half would have to be reduced to ten percent of five hundred dollars or fifty dollars on that amount.
b. The Exceptions: In regard to usury, a loan to be used primarily for home improvement or home purchase is not regarded as a loan for personal, family or household purposes. With these loans and for any other loans which are not for personal, family or household purposes, the allowable rate is the higher of 10% or 5% over the amount charged by the Federal Reserve Bank of San Francisco on advances to member banks on the 25th day of the month before the loan (if the agreement to loan and the actual lending of the money are in different months, the 25th day of the month before the earlier event is used).
The usury laws do not apply to any real estate broker if the loan is secured by real estate.
This applies whether or not he or she is acting as a real estate broker.
The limitations also do not apply to most lending institutions such as banks, credit unions, finance companies, pawn brokers, etc. State laws place limitations on some of these loans, but at a higher percentage rate than the usury laws listed above.
Time payment contracts (for example: retail installment contracts and revolving accounts) are not generally regarded as loans. The usury laws normally do not apply to them. There are no limits on finance charges for the purchase of personal, family and household goods or services at this time.
Banks take the position that the charges for third party credit cards (Visa, MasterCard, American Express, etc.) are not subject to these limitations and charge interest far, far in excess of the usury limits, compounded daily. (Many credit cards offer low introductory rates but if you miss even a single payment by a single day, impose their “usual” rates which can be above eighteen percent compounded daily thus in excess of 22% annually…all perfectly legal.)
In transactions for the purchase of goods or services which are not for personal, family or household purposes, there are normally no limits to finance charges except those set by the parties.
In the absence of an agreement between the parties as to what is the rate of interest, the law imposes a rate of seven percent.
Penalties placed upon the violator of the usury laws range from criminal prosecution in extreme cases involving organized crime to forfeiture of all interest (not just the usurious part) of the Note.
Before making any loan, the reader will be well advised to read our article on Promissory Notes: The Basics as well as Binding Contracts and should further get legal advice as to the appropriate rate of interest that the law would allow.
But note that the truly large lenders are exempt from the usury laws. As one client put it, “They restrict us little guys and let the ones who truly need limits put on them charge whatever they want. That’s crazy.”
Perhaps…but it is also the law. Learn it.