A usury prohibition seems like it would be one of those laws that are simple to understand. The state sets a maximum rate that a lender can charge a borrower on a loan. Preventing excess interest rates was considered such a fundamental proposition that a usury prohibition was included in the United States Constitution and one is also included in the California Constitution. However, the many exceptions and exemptions to the usury laws in California make the subject an extremely complex one.
Basic California Usury Law
The core usury law in California is found in Article XV of the state Constitution. It provides that a maximum interest rate for loans used for personal, family or household purposes is 10 percent a year. The interest rate on loans for business and other purposes is either 10 percent a year or 5 percent a year above the interest rate established by the Federal Reserve Bank of San Francisco on the 25th day of the month preceding the date of the loan, whichever is greater.
Any interest above this amount is usurious if none of the many exemptions and exceptions apply. A borrower can have a usurious interest rate voided in California, and can recoup treble damages for any usurious interest paid.
But don't get too excited. Most big lenders like banks, savings and loan associations, credit unions, personal property brokers, pawnbrokers and pension or retirement funds are exempt from the usury laws.
California Usury Law Provisions
In the California Constitution, Article XV sets out the state's basic law on interest rates. It sets out a default interest rate of 7 percent a year when no other provision in the law applies. However, it allows parties to contract for a higher interest rate, with one maximum contractual rate (10 percent a year) established for loans used for family, personal and household purposes, and another for loans used primarily for other purposes (5 percent over the Federal Reserve Bank interest rate). The latter category includes commercial loans and business loans.
While this may seem clear enough, exemptions to the usury law cut back on the protections it appears to offer. For example, in the same paragraph that sets out the interest rate for loans used for personal, family and household purposes, the provision exempts any loan used to buy, repair or build a home from that category.
Other exemptions follow hot and heavy both in the Constitutional provision and also in many California statutes including provisions in the Civil Code, Commercial Code, Corporations Code, Financial Code and Government Code. Once the exemptions and exceptions are considered, usury protections seem narrow indeed.
California Usury Law Exemptions
Anyone reading for the first time about the exemptions to the usury law in California may well be amazed to learn about the types of companies which can make loans without worrying about interest limitations. For example, the usury limitations do not apply to most lending institutions in the state, like banks, credit unions, savings and loans, finance companies and pawn brokers. Some loans from these lenders are capped by state law at a higher percentage rate than the general usury laws, but many are not regulated at all.
Another big exemption is made for loans made or arranged by a licensed real estate broker and secured in whole or in part by a lien on real property. This applies whether or not the person is acting as a real estate broker in the transaction or not, as long as they are qualified as a real estate broker.
And any loan in which the lender takes part of the appreciated value of the property securing the loan need not comply with the usury law. Usury is defined as regulating the "borrowing or lending or forbearance of money," so usury is found not to apply where a seller offers property at a low price for cash or a much higher price on credit. This is called the “time price doctrine.”
Usury Exemption for Retail Installment Contracts
At this point you may be wondering about your credit card interest rates. You may have a low starter rate, but you know perfectly well that if you miss a payment, the interest rates can soar up to 18 percent compounded daily. Yes, there's another exception at play here, for time payment contracts.
California statutes do not specifically exempt time payment contracts, but they are simply not treated as loans. This includes retail installment contracts and revolving accounts. Since they are not deemed loans, California usury laws don't apply to them. In fact, the law doesn't impose any limit at all on finance charges for the purchase of personal, family and household goods or services. Nor are there any finance charge limits for the purchase of goods or services for other purposes.
Some debate whether credit cards like Visa and American Express are retail installment contracts or loans. But banks treat charges for third party credit cards as installment contracts that are not subject to usury limitations.
Constitutional Penalties for Making Usurious Loans
The range of penalties for usurious loans might surprise you. A lender convicted of charging usurious interest may have to forgo interest or they may be prosecuted and sent to jail.
Article XV of the California Constitution provides quite clearly that a usurious contract is unenforceable. This would seem to mean that a lender charging a usurious interest rate would lose the entire amount of principal and interest due. In fact, the courts usually interpret a contract in a way that makes the loan rate less than the usury amount and allows for return of the principal.
Other Penalty Provisions in California Statutes
California statutes impose more severe penalties. The Civil Code section 1916-2 can be read to prevent a lender who has charged usurious interest from collecting any interest at all. It can also delay repayment of the principal until the full period of time for which it was contracted has elapsed.
And the following section (Civil Code 1916-3) allows a borrower who has made usurious interest payments to recover damages of three times the amount paid. That is, if the borrower has paid $1,000 in usurious interest, he can sue for $3,000.
The statutes also allows for criminal penalties of up to five years in prison for the felony of loansharking. It provides: b__) Any person who willfully makes or negotiates, for himself or another, a loan of money, credit, goods, or things in action, and who directly or indirectly charges, contracts for, or receives with respect to any such loan any interest or charge of any nature, the value of which is in excess of that allowed by law, is guilty of loan-sharking, a felony, and is punishable by imprisonment in the state prison for not more than five years or in the county jail for not more than one year.
Finally, some lenders who violate the usury laws can be held to violate the Unfair Practices Act found in Business and Professions Code §17000, et. seq. This can also expose them to criminal liability.
Avoiding Problems With Usury
It can't help but annoy an average citizen that the largest lenders in the state are exempt from usury laws. But don't let this inequity push you into taking actions that can haunt you. The law is the law, and if you don't fit into any of the exempt categories, comply with the usury laws. A simple loan can turn into a nightmare legal mess if you lend money without understanding the law and planning to comply with it.
"Neither a borrower nor a lender be," Polonius advises his son in Shakespeare's Hamlet. But if that's not advice you can follow, consider consulting an attorney before you make a loan to avoid trouble.
Teo Spengler earned a JD from U.C. Berkeley Law School. As an Assistant Attorney General in Juneau, she practiced before the Alaska Supreme Court and the U.S. Supreme Court before opening a plaintiff's personal injury practice in San Francisco. She holds both an MA and an MFA in English/writing and enjoys writing legal blogs and articles. Her work has appeared in numerous online publications including USA Today, Legal Zoom, eHow Business, Livestrong, SF Gate, Go Banking Rates, Arizona Central, Houston Chronicle, Navy Federal Credit Union, Pearson, Quicken.com, TurboTax.com, and numerous attorney websites. Spengler splits her time between the French Basque Country and Northern California.