A Note on California’s Usury Interest Laws for Consumer and Non-Consumer Loans
It’s not news that while the economy as a whole has tightened its belt, banks and other institutional lenders have become more reluctant to approve loans for individuals and small businesses. In turn, the need to borrow money has only increased, forcing many of these individuals and small businesses to seek out loans from other individuals and companies in order to ride-out the economic downturn.
Before considering lending or borrowing money, it is important to know that California holds some of the harshest and strictest penalties on lenders of consumer loans who charge interest in excess of the maximum legal rate. This includes treble damages, a felony charge, and jail time –even if the borrower knowingly enters into a written contract to pay interest at the higher rate and pleads with the lender to do so.
This article will give a brief overview of California’s usury interest laws and outline steps to take to avoid legal action.
What is California’s Usury Interest Law?
In California, there is a cap on the amount of interest that can be charged on a consumer loan. California’s usury law limits the interest rate on consumer loans to a maximum of 10% per year (equaling a maximum of .833% per month). ”Usury” is the charging of interest for a loan or forbearance on money in excess of the legal maximum. ”Interest” could be defined as anything of value that the lender receives directly or indirectly from the borrower, including fees, bonuses, commissions, and other miscellaneous charges. “Forbearance” generally describes an agreement by the lender to extend the due date on an existing loan and refrain from taking legal action in return for an increased interest rate or a bonus.
California’s usury law is primarily codified in Article XV Section 1 of the California Constitution, but is further detailed in 10 different code sections which provide for a plethora of exceptions, mostly in favor of those institutions that are in the business of lending money. Pursuant to the California Constitution, these code sections and case law, non-exempt lenders such as individuals and most small businesses can charge a maximum of 7% interest per year on a consumer loan not expressed in writing, and up to a maximum of 10% interest per year if memorialized by written contract. A “consumer loan” is an amount of money, goods or things lent to a borrower primarily for personal, family or household purposes. For all other loans, including those for home improvement, home purchase, business purposes, etc., a lender can charge the greater of 10% per year, or 5% plus the Federal Reserve Bank of San Francisco’s discount rate on the 25th day of the month preceding the earlier of the date of the loan is contracted for, or executed. (The current discount rate as of March 16, 2012 was .75%.)
The compounding of interest, that is the charging of interest on interest that has already accumulated, is prohibited in California unless both parties have agreed to it in writing. Otherwise, the interest must remain as simple interest on the outstanding balance only, over the life of the loan. Also, for a loan to be usurious, it must be expressed in writing. Without a sufficient written contract, the courts have held that there is no valid expression or consideration, and therefore there is no obligation on the borrower to pay the usurious interest. If interest is collected in this manner above the maximum legal rate when there is no written contract, the interest is simply allocated to the principal.
Although “intent” by the lender to charge a usurious interest is an element of usury, intent will simply be presumed if the court deems the loan to be usurious, and the borrower need not prove actual intent or even knowledge by the lender. The lender’s mistake of law or ignorance of the law is no defense, even if the borrower drafts the agreement and proposes the higher interest rate.
A specific exception may exist as some courts have held that the lender is not subject to the penalties in certain extreme cases of borrower misconduct during the formation of the agreement…
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