Clarifying California’s Complex Usury Laws

October 14, 2019 by Melissa C. Martorella, Esq.

It’s a common misconception that you can charge any interest amount as dictated by the market.

The truth is that in the majority of scenarios, a non-exempt lending entity is capped at collecting ten percent annually on a loan, regardless of the borrower’s wishes to pay an elevated interest. Borrowers and lenders alike need to be cognizant of the potential for usurious loans, as the associated penalties can be severe.

Understanding Usury

The term usury refers to the act of charging interest at a rate over the statutorily mandated maximum. California judicial precedent has defined “interest” to include anything of value received by a lending entity from the borrower notwithstanding the specific type of consideration—meaning payments submitted via fees, bonuses, commissions and similar charges could all be considered interest.

California’s usury statute restricts the amount of interest that can be levied on any loan or forbearance. According to California law, non-exempt lenders can place a maximum of ten-percent annual interest for money, goods or things utilized mainly for personal, family or household purposes. For other types of loans—including but not limited to home improvement, home buying and business expenses—non-exempt lenders can charge the greater of ten percent annual interest, or five percent plus the Federal Reserve Bank of San Francisco’s discount rate on the 25th day of the month preceding the earlier of the loan’s date of execution. In simpler terms, the rule-of-thumb is that a non-exempt lender is prohibited from charging more than ten percent annually barring a pertinent exemption.

Consequences of Usurious Loan Claims

Identifying exactly when a California-based loan is usurious can be tricky, given the myriad of legal exemptions scattered throughout multiple federal and state code sections. A loan will generally be considered usurious when the interest rate is higher than the max amount set forth by statute. The lender’s knowledge is immaterial, meaning that the plaintiff does not have to prove intent, and ignorance of the law is not a viable offense for defendants. For example, a borrower could propose and draft a note with a usurious interest rate, and the associated non-exempt lender would still be found liable for collecting on the loan.

Usury claims are clear-cut and thus extremely challenging to mount a defense against—unless, of course, there is an applicable exemption. However, there is the possibility that the lender and borrower mutually agree to adjust a usurious loan or forbearance agreement in order to make it legally compliant. The California appellate court has ruled that a usurious note can be purged of it usurious terms if both parties to the agreement voluntarily and with full knowledge of the noncompliant format of the original note form a new agreement and the lender credits the borrower with the amount of excess interest paid in the preexisting exchange.

If a loan is ruled usurious, the originator may face stiff civil penalties. The borrower has several potential cumulative remedies, including: bringing an action for monetary damages for all funds paid over the two-year period preceding the suit; seeking damages equivalent to three times the interest paid over the course of the twelve months preceding the filing of a claim; seeking a judgment to eliminate all future interest that will come due for the remainder of the loan; and recovering punitive damages if the lender’s behavior is deemed oppressive, fraudulent or malicious. The impact of this statutory framework is that a usurious loan can potentially transition into an interest-free loan with the added threat of expensive damages and criminal charges. Willfully violating the usury guidelines may also be deemed a violation of Business & Professions Code § 17000, resulting in an additional criminal charge for the guilty party.

Common Usury Exemptions

As previously mentioned, the California statutory code is rife with usury exemptions. The following is a brief overview of some of the more commonly utilized exemptions.

Licensed Lending Entities

The majority of licensed lending institutions involved in the business of granting consumer and/or commercial loans such as banks, savings and loan, credit unions and finance corporations are exempt from California’s usury regulations.

Certain Real Estate Secured Loans

Loans that are made or arranged by a real estate broker with an active California license and is secured either entirely or partly by a real property lien can be exempt from California usury statute if the terms and conditions of its origination and negotiation are executed correctly. To qualify for exemption, the broker must be more involved than merely performing escrow services on a loan—specifically how much more involved depends on the circumstances of the associated transaction.

Certain Real Property Loans

Real estate loans obtained in order to buy real estate, build a home or structure, or to make improvements may be exempt if the loan is made or arranged by a real estate broker.

Seller Financed Loans

A seller “carry back” loan occurs when the seller of California real estate funds the purchase for the buyer with a deed of trust secured note. In these scenarios, the seller is performing the function of the lending institution. Commonly, a seller will offer to carry back all, or a part of, the purchase price in an effort to sell the home—especially if the banks will not extend a loan for the total sum of financing required to fund the ideal purchase price. Some California courts have ruled that these types of situations are not in fact loans, but sales on credit, making them exempt from the state usury law.

Time Payment Agreements and Credit Cards

The Unruh Act promulgated by the California Civil Code pertains to the financing of consumer goods under a retail installment sales contract via which a seller funds the buying of its consumer goods or services and the purchaser agrees to payment in installments. Pursuant to a recent holding by the California Supreme Court, if a bona fide retail credit sale is subsequently mutually altered by the parties, the resulting settlement is exempt from usury. Similarly, all credit cards are exempt from usury regulations.

Licensed Pawnbrokers—To an Extent

As defined in the California Financial Code, a pawnbroker is any individual “engaged in the business of receiving goods, including motor vehicles, in pledge as security for a loan.” The same statutory clause also mandates that pawnbrokers can only charge up to 2.5% monthly interest.

Loans Extended to Certain California Businesses

Loans that are made to California-based corporate entities that have at least $2 million in assets or are for more than $300,000 are potentially exempt from usury regulations if: a) The lender and borrower have a previous personal or business relationship; or b) The lender and borrower can reasonably be assumed due to their experience to have the ability to protect their own interests related to the transaction and the loan is for business purposes and is not guaranteed by an individual, a revocable trust, or a partnership that has a general partner.

California’s legal framework means that a seemingly straightforward loan can morph into a catastrophic mess of criminal and civil penalties—regardless of whether the guilty party even intended to violate the law. When borrowing or lending money, consider the potential effect of the usury regulations and consult a trusted California lawyer who is well-versed in California’s complex statutory system pertaining to usury issues. Being proactive now can help prevent costly fines and wasted time down the road.

Have questions about California (or nationwide) usury rules? Reach out to one of our experienced Banking & Finance attorneys who can walk you through usury rules and exemptions in all 50 states.

Melissa Martorella
Attorney, Banking & Finance
(949) 535-1512