California Interest Rates Laws: What is Usury?

Most people are aware that usury laws limit the amount of interest you can charge when you loan money. Each state has a usury law and California's is found in its Constitution in article XV. Thanks to special-interest exceptions, the law isn't going to keep down your mortgage or credit card interest, but you'll need to know it if you decide to loan money to a friend.

The key points of usury law in California include:

• The default interest rate is 7 percent a year. 
• Parties can contract for interest on a loan for household purposes at a maximum of 10 percent per year.
• Loans for home purchase or improvements are not considered for household purposes, but business. They carry a maximum interest rate of 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 loan. 
• Most loans from banks and other big lenders are excluded from usury protections.
  
  Read More: California Usury Law

Today usury means charging too high a rate of interest on loaned money, but for a very long time it meant charging any interest at all on loaned money. For some four thousand years, usury has been repeatedly condemned, prohibited and scorned on moral, ethical, religious and legal grounds. Even the Bible references it as a sin. And in Dante's Inferno, usurers wound up in the same circle of hell as the inhabitants of Sodom and others who practice unnatural vice.

The core argument against charging interest on loaned money came from the Church. It condemned interest on loans because it constituted unearned income, gain acquired from the use of a thing without labor, expense or risk by the lender. This changed the place of money from being simply an abstract mechanism to balance supply and demand to being an end in itself, a self-perpetuating power.

Usury's bad rap was made worse by the practice of throwing debtors in debtor's prison, common from the time of the ancient Greeks right up through the founding of this country. As a result, the United States Constitution specifically prohibits debtors' prisons and usury, and it also permits bankruptcy, a legal procedure to eliminate debt. All states have the right to establish caps on interest rates.

Given all of the anti-usury language in the U.S. Constitution, you might think that similar laws might have real traction in liberal California. But although the state Constitution contains similar language, the California law prohibiting usury is riddled with special-interest exceptions. While it regulates the interest you can charge a friend on a loan, it doesn't limit the interest you pay to banks, mortgage holders or even credit cards.

The constitutional provision about usury provides that the rate of interest upon the loan or forbearance of any money, goods, or things in action, or on accounts after demand, shall be 7 percent per annum. However, the provision has significant exceptions. These include the ability to contract for higher interest rates in certain circumstances, such as when:

• The money is for personal, family or household purposes, at a rate not exceeding 10 percent.
• The money is for any other purpose, at a rate not exceeding either 10 percent or 5 percent plus the prevailing Federal Reserve Bank rate on advances to member banks on the 25th day of the month before the loan, whichever is greater.

California Civil Code Section 1916.2 appears to allow a maximum interest rate of 12 percent a year on money borrowed for household purposes. This seems to conflict with the 10 percent maximum of Article XV.

The California Constitutional provision provides that loans used to buy, build or improve a home are not made for "family or household purposes." That means that they are not subject to the 10 percent interest cap. None of the big lenders are ultimately restricted in the interest rates they charge by this provision, including mortgage holders with a security interest.

Other outright exceptions to these restrictions found in the California Constitution include loans made or arranged by:

• Banks. 
• Building and loan associations. 
• Nonprofit cooperative associations loaning money under the Agricultural Credits Act of 1923. 
• Pawnbrokers.
• Personal property brokers.
• Real estate brokers. 

California statutes are also replete with exceptions to the usury law set out in the constitution. For example, the statutes makes certain exceptions, which include:

• Real estate broker-arranged loans [Civil Code section 1916.1].
• Public retirement or pension system [Civil Code section 1916.2]. 
• Incorporated insurer [Insurance Code section 1100.1].
• Licensed broker-deals [Corporations Code section 25211.5]. 
• Indebtedness issued pursuant to corporate securities law [Corporations Code section 25116]. 
• Licensed business and industrial development corporation [Financial Code section 31410]. 
• State and national banks acting as trustees [Financial Code section 1504].
• Foreign banks [Financial Code section 1716].
• State and federal savings and loans [Financial Code section 7675]. 

The California Constitution sets the maximum rate of interest on a judgment awarded a plaintiff in any court in the state. It gives the legislature the right to set the interest rate as high as 10 percent a year, but sets the default rate – in case the legislature doesn't act – at 7 percent a year. The legislature has set this rate at 10 percent in California Code of Civil Procedure Section 685.010.

If you wonder why your credit card interest rate is so high, you'll want to know about the retail installment exception carved into the usury protections. Contracts for purchase of goods that are payable over time, like retail installment contracts and revolving accounts, are not considered loans under the law. That means that the usury laws do not apply to them.

In fact, if you purchases personal, family or household goods or services, the rule is buyer beware. There are no limits to the finance charges the lender can impose. This also applies to buying goods or services that aren't for household purposes.

California banks assert that their charges for third party credit cards like Visa and MasterCard are not subject to usury limits since they are a form of retail installment contracting. The amounts that credit cards charge in interest have no relationship to the amounts listed as permissible in the usury law. They charge as much as 18 percent or more, compounded daily rather than the 10 percent for household goods set out in the Constitution.

If a lender makes a loan charging an interest rate that the law in California considers usurious, the interest provision is voided. How about the principal? While the Constitutional provision on usury states that usurious contracts are unenforceable, suggesting that the lender cannot reclaim any amount, but this is usually not the result. The courts usually allow the lender to collect the principal amount, noting that the underlying intent of the usury laws is to prevent lenders from getting excessive interest, not lose their principal.

What if a lender has already collected interest on a usurious loan by the time the borrower objects? The borrower can recover treble damages; that is, three times the amount of the usurious interest paid. The borrower has only one year from the date of payment of usurious interest to file suit to recover treble damages. A suit to simply recover the actual interest paid can be brought within two years.

The same state that provides for treble damages, Civil Code 1916-3, imposes criminal penalties of up to five years in prison for the felony of loansharking. Criminal penalties are also possible for lenders who violate the usury laws under the Unfair Practices Act found in Business & Professions Code §17000, et seq.