Maximum interest rate laws, also known as usury laws, limit the amount of interest businesses can charge for loans. This is meant to protect consumers from excessive interest rates and from going into lifelong debt. But California’s usury laws have a long list of exceptions that include most traditional lenders. What this means in practice is that typically only loans between individuals, families and small businesses are covered under the law. Also, the maximum interest rules are complex, making them difficult to understand for both consumers and businesses. If you believe you have been charged illegal interest rates, there are legal remedies available. However, first you must make sure that your lender is not fall under one of the many exceptions to California’s usury laws, and you must also ensure that the loan terms are, in fact, illegal.
Personal, Family or Household Loans
Maximum interest rate laws essentially limit how much a lender can charge on debt. An interest rate that exceeds the legal limit set by law is called a usury rate. Usury laws are in place in most states. Some states set a fixed interest rate limit such as 10 or 15 percent, while other states base the rate limit on the discounted interest rates offered by government lenders. The legal interest rate in California is based on a combination of the two.
The California Constitution lays the foundation for the Golden State’s usury law, and other civil codes add relevant provisions. The law states that a consumer loan for personal, family or household purposes cannot exceed a 10 percent interest rate per year. One thing to understand about California usury law is that this rate is based on the unpaid balance at the end of the year. Basically, the law uses a simple interest rate calculation, rather than a compound one. For example, let’s say you take out a one-year personal loan for $2,000. If at the end of the year, you have made no payments and you plan to pay the balance in full, the lender can charge you 10 percent of the balance, or $200 for interest. However, if you made monthly payments on that loan throughout the year, you would pay significantly less interest on the loan. This is because the lender can only charge you based on the unpaid balance at the end of the year. So, if you made $100 payments each month, paying off $1,200 of the loan, you could be charged only 10 percent on the remaining $800. This means your final interest payment could total no more than $80.
Note that usury laws are often riddled with exceptions, making it difficult to understand whether any given loan falls under the law. These rules are confusing, and it’s relatively easy for a consumer to enter into a usurious contract without even realizing it. That’s why it’s important to understand California usury rate interest laws before you sign any contract with a lender.
Other Types of Loans
Besides personal, family or household loans, all other loans fall under the “other” category of the law. Interestingly, this includes loans for home improvement and home purchase, which for some reason do not fall under the personal, family or household group. So basically, home loans and any other loan that doesn’t fit within the personal, family or household category are subject to different rules for maximum interest rates. The allowable rate for these loans is the higher number of these two options:
- 10 percent, or
- The discount rate charged by the Federal Reserve Bank of San Francisco on the 25th day of the month prior to the loan being issued, plus 5 percent.
This rule sounds confusing on its face, but it’s actually somewhat simple. The allowable rate is the greater number of 10 percent or 5 percent, plus whatever the Federal Reserve Bank of San Francisco’s discounted rate is. So, it stands to reason that if the FRBSF rate is less than 5 percent, the maximum allowable interest rate is 10 percent. The trick is that the Federal Reserve Bank of San Francisco’s rate is constantly changing, making it a variable rate. But if you look at the FRBSF’s rates historically, they have been below 5 percent for the last decade. So, for the last decade, 10 percent has been the greater number of the two. Thus 10 percent has been the legal rate limit for the "other" grouping of loans, as well as the category for personal, family or household loans. If the FRBSF’s discount rate goes above 5 percent in the future, the maximum interest rate for home loans will rise above 10 percent, too.
Note that California usury laws don’t apply to real estate brokers if the loan is backed by property. There is also an exception for loans used to purchase, build or improve property if handled by a broker. Because of this exception, licensed real estate brokers can charge above the maximum allowable interest rates. There are other exceptions to the law too, but this is probably the most common exception that affects everyday consumers.
Exceptions to California Maximum Interest Rate Law
There are numerous exceptions to the legal interest rate in California. In fact, there are so many common exceptions that many consumer advocates claim that the California usury laws actually apply very narrowly. These are the most common exceptions to California usury laws:
- Real estate brokers: Licensed real estate brokers in California can get around the maximum interest rate laws if the loan is secured by property. Also, loans used to purchase, build or improve property are exempted from the law if handled by a licensed real estate broker. This is an exception that affects many consumers and is helpful to understand if you plan to use a broker to take out a home loan. Note that this exception can be made even if the borrower is an individual.
- Credit cards: Credit cards are another exception to California's maximum interest rate law. This is because credit card companies charge interest rates based on the state they are incorporated in. They are not obligated to change their interest rates based on where consumers using the credit cards live. This gives credit card companies a huge advantage. Most choose states with loose regulations to set up business, such as Delaware. This is allows them to charge whatever rate they want, and it’s up to consumers to avoid being taken advantage of by unreasonable rates.
- Licensed lending institutions: This exception tends to raise eyebrows. The California usury law makes exception for all licensed lending institutions involved in making consumer and commercial loans. This includes banks, credit unions, financing companies, pawn brokers, residential mortgage lenders and other licensed lenders. Basically, any lender that is licensed under California law is exempted from maximum interest rules. In practice, this includes many, if not most institutions a consumer would traditionally go to for a loan. Meanwhile, smaller companies must follow the law.
- Retail accounts: If you have a credit account with a retailer, your account is likely not covered by California’s general usury laws. These accounts are deemed time payment contracts, and so are typically governed by industry-specific laws. This type of contract is exempt from usury laws.
- Commercial borrowers: For certain commercial transactions, there is an exemption in the California usury law. These exceptions include loans totaling more than $300,000 during the creation of the loan, or when the commercial borrower has $2 million or more in assets at the time of the loan. In order for these exceptions to kick in, the borrower must be a commercial enterprise, such as a business or an LLC. Further, the borrower and lender must have a previously existing relationship or the commercial borrower must have the ability to understand and protect their financial interests during the transaction. Lastly, the loan must be for commercial purposes.
- Small loans to high-needs borrowers: California maximum interest rate laws partially exempt certain lenders who offer loans to high-needs borrowers. These lenders include personal property brokers, industrial loan companies and pawnbrokers. They can offer loans for up to $2,500 and are able to charge higher interest rates than the usury laws allow.
With all these exceptions, it can seem like the law exempts more lenders than it covers. The reality is that California’s usury laws apply to a relatively small sector of loans. If you plan to utilize the protections of the law, it’s important to first understand these exemptions and how they function. Unfortunately, if you are working with a licensed lender such as a bank, broker or insurance company, you are out of luck. If you are working with a smaller business not covered by one of these exceptions, there may be a legal remedy available to you.
Remedy Available to Consumers
If you believe a nonexempt lender violated California usury laws in your loan agreement, there are some legal remedies you could be entitled to:
- The illegal interest rate will be declared void. As a result, the lender must release you from your obligation to pay any interest on the loan at all for the rest of its term.
- You will be paid back for all interest you paid over the last two years. The two-year period goes back from the date the lawsuit was filed. If the lender takes you to collections, all usurious payments you made over the life of the loan could be subtracted from your principal.
- Any interest you paid in the year prior to the lawsuit could be subject to treble damages, meaning the court will order the lender to pay you back three times the amount you paid in interest during that year. This is to penalize lenders and incentivize them to stay within the bounds of the law. Note that treble damages only go back one year, and you will be repaid all interest for the second year.
Statute of Limitations
One thing to note about California maximum interest rate laws is that there is a statute of limitations of two years for recovering excess interest paid. Note also that you can only recover interest paid, not the full amount of the loan. So, let' say in the example of the one-year $2,000 loan in which you paid $1,200 throughout the year, the lender ended up charging you interest equaling 10 percent of the full loan, or $200. For up to two years after the usurious payment, you are able to challenge that lender in court. However, you are only able to challenge the $200 interest, not the full amount of the loan.
An exception to the statute of limitations is those cases where the statute doesn’t kick in until the loan is fully repaid. Further, treble damages can only go back one year, and cannot be granted by the court going back further than that.
- Capobianco Law: Avoiding the Usury Trap
- FRBSF: Discount Rate
- Gehres Law: California Usury Laws: What You Should Know Before Lending or Borrowing Money
- California Constitution: Article 15 Usury
- State of California Department of Justice: Consumers USURY
- Reicker Pfau Law: Making a Loan? Be Careful of Usury Laws
- Investopedia: Legal Rate of Interest