Making a Loan? Be Careful of Usury Laws
California law imposes strict penalties for violating usury (charging excess interest) laws which makes it important for anyone making a loan to understand these laws.
The lender on a usurious loan is subject to the following civil penalties: (1) forfeiture to the borrower of all interest on the loan, not just the usurious part; and (2) payment to the borrower of triple the amount of interest collected in the year before the borrower brings suit.
Additionally, a lender who willfully receives interest in violation of the usury laws is guilty of loan sharking, a felony punishable by imprisonment for up to five years.
With such serious ramifications, it is important to understand when a loan is usurious.
California Usury Law Summary
For consumer loans, the parties may contract for interest on a loan primarily for personal, family or household purposes at a rate not exceeding ten percent per year. A loan to be used primarily for the purchase, construction or improvement of real property is not regarded as a loan for personal, family or household purposes.
For all other loans, the allowable rate is the higher of (a) ten percent; or (b) five percent over the “discount rate” charged by the Federal Reserve Bank of San Francisco on the twenty-fifth day of the month before origination of the loan. As of September 1, 2013 the applicable Federal Reserve Bank rate was 0.75%, meaning that any non-exempt loan bearing interest at greater than ten percent would be usurious.
An important thing to note is that the maximum interest rates refer to the simple interest rate on the unpaid balance, not compound interest.
Exemptions to Usury Laws
California does provide a large number of exemptions from its usury laws which lenders should try and fall within.
Two of the most common exemptions from the California usury laws for commercial transactions apply to loans in excess of $300,000 at the time they are created; or, where the borrower has assets of at least $2,000,000 at the time the loan is created. In order to qualify for either of these exemptions, the borrower may not be an individual (i.e. the borrower should be an LLC or some other type of business entity), the lender must have a pre-existing relationship with the borrower or reasonably appear to the borrower to have the capacity to protect its own interests in the transaction, and the loan must not be primarily for personal, family or household purposes.
The easiest exemption to the usury law to qualify for is a loan made or arranged by licensed real estate broker that is secured in whole or in part by a lien on real property. This exemption is the easiest one to fall under because the borrower can be an individual and does not have to have any minimum net worth. A licensed real estate broker simply needs to facilitate the transaction, or act as the lender and the loan must be secured by real property.
Other exceptions (although less common) to the usury laws are loans or other indebtedness that are:
- Rated by S&P as AAA, AA, A, BBB, or investment grade commercial paper or by Moodys as Aaa, Aa, A, Baa, or investment grade commercial paper;
- Were the borrower has any security listed on a national securities exchange or NASDAQ;
- Where the borrower is a reporting company under the Securities Exchange Act of 1934, had total shareholders equity of at least $1 million at the end of its most recent fiscal year, and had consolidated net income of at least $500,000 for three of its last four fiscal years; or
- The loan is issued pursuant to the issuance of a securities permit from the California Department of Corporations.
Additionally, usury laws provide exemptions for other lenders that are licensed individuals and entities. The usury laws also do not apply to licensed securities broker-dealers acting pursuant to a certificate which is then in effect. The usury laws also do not apply to loans made by or obligations of most financial institutions such as banks, savings and loan associations, and credit unions or by insurance companies.
he usury laws also do not apply to bank charges for credit cards.
California law also partially exempts certain lenders, who lend to individuals who are in the greatest need of loans. Consumer finance lenders making loans with a principal amount of less than $2,500, personal property brokers and licensed pawnbrokers, and industrial loan companies are subject to higher interest rate restrictions than those imposed by the usury laws.
The usury laws do not apply to time payment contracts either. Examples of these are when a seller finances the purchase of real or personal property by extending payments over time.
Statute of Limitations
The statute of limitations for recovering interest paid on a usurious loan is two years and only the amount of interest paid within that two year period is recoverable. Exceptions include: (1) cases where the statute does not begin to run until after the borrower repays the loan; (2) if the lender sues to enforce a usurious loan contract, the borrower may assert a usury cross-complaint for all the interest paid on the loan as an offset without regard to the statute of limitations.
The statute of limitations for recovering treble damages on a usurious loan is one year, regardless of whether the loan has been satisfied or whether the lender is attempting to enforce a usurious loan. As a result, a borrower would be able to recover treble damages going back one year and recovery of all interest paid going back two years.
While most professional lenders are exempt from the usury laws, problems can arise when ordinary nonexempt companies or individuals make loans. The harsh consequences of violating the usury laws make it important for lenders to look carefully at the usury laws and exemptions, especially as the exemptions are not always straightforward or intuitive.