Staying Under the Limit An exploration of Usury

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Usury is a term that refers to the law that sets a maximum interest rate on certain loans in a given state.  These laws vary tremendously from state to state, including some which have no limits, at least with respect to business-purpose loans.  Naturally, a state wishes to balance the needs of lenders to charge interest to earn a fair return and as a hedge against risk, with the needs of borrowers to not be gouged by bad actors.  To that end, states have been quite creative in devising a multitude of frameworks for addressing usury.  This article will explore usury in general terms, and look at a few states as examples.

Usury Generally

A little more than half of the states have at least some limitation on interest rates that can apply to business purpose loans.  Most of these states usury laws apply to a very narrow subset of loans by creating more exceptions than there are rules, and others have limits that are so high, most lenders wouldn’t even need to worry about approaching those amounts.  Usury laws are generally written to state an over-all limitation, and then to provide significant exceptions, or at least partial exceptions.  Exceptions are usually made based on the following factors: 

  • The dollar value of the loan,
  • Whether the borrower is an entity or an individual,
  • Whether the property is residential or commercial,
  • Whether the property is owner-occupied,
  • Whether the lien is senior or junior, or
  • A combination of some or all of these.

Specific Examples

In New York, the usury law caps interest at 25%, but this limit no longer applies to any loan with a value of $2.5 million or more.  Below that, the rate could be either 16% or 25% depending on other factors such as whether the borrower is a corporation, LLC, or LP, whether the loan amount is greater than $250,000, and the number of residential units in the property. 

In Oregon, if the loan amount is $50,000 or less, is a junior lien, and was not made as part of a purchase transaction, then the usury law caps interest at the greater of 12% or 5% over the 90-day commercial paper discount rate, as applicable.

In California, a different regime is at play.  The state constitution sets the usury limit of 10% and allows for the legislature to exempt certain other classes of persons from usury.  Among other things, the legislature has made two main exemptions: A loan made or arranged by a licensed real estate broker, and a loan made by a licensed lender under their CFL program.  There are certain other caveats within these exceptions, however.  See our other articles on these topics for more information [link]. 

Additional Considerations

In most states, fees paid to the lender, such as origination fees, exit fees, extension fees, processing fees, etc. will be considered as equivalent to interest and thus included in the interest calculation.  For example:  A $100,000 loan with 12% note interest and a 12-month term.  If a 2% origination fee is charged, it will be a total APR of 14%.  If the loan term were only 6 months, however, the same 2% irrigation fee must be compressed over half of the time, resulting in double the effective rate, for a total APR of 16% (12% note rate plus 4% effective rate for the origination fee). 

Potential Penalties

“Committing usury”, that is, making a loan with interest above the limit, can result in a range of penalties, from the simple – repayment/crediting of the usurious amount – to the severe – fines and imprisonment.  Criminal penalties are, of course, quite rare, but they do happen.  Courts will also often require a forfeiture of more than just the usurious amount to require double or triple the usurious amount to be repaid or credited.  It is also possible to lose all of the interest paid as well as the entirety of the principal.  Usury issues should not be taken lightly as penalties can be severe.

Avoiding Issues

The easiest way to avoid the usury issue is to make sure the interest rate, inclusive of fees, is below the limit, or to structure the loan such that it falls within the parameters of an exception.  Another way is to use a different state’s law as the governing law of the loan.  For example:  A loan where the property is in California, and none of the usury exceptions apply so the rate is otherwise capped at 10% – and the borrower lives or is based in California, but the lender operates out of Connecticut.  The lender could use Connecticut law to govern the loan (other than the deed of trust securing the property) and because Connecticut law has a broad exception to usury, the lender could avoid the limit otherwise present in California. 

Significant caution should be exercised in choosing the governing law of a loan.  There must be a proper “nexus” between the parties, the property, and the loan for a certain choice of governing law to be enforceable.  We strongly recommend that an attorney is consulted before making governing law decisions.

Concluding Thoughts

Usury as a concept is easy to understand, but its implementation can be vexing.  As its impacts and penalties for violation are significant, special attention must be paid to compliance.  The attorneys at Geraci LLP are experienced and well versed in usury-compliance issues, and are happy to discuss specific circumstances and provide guidance on making the loan work within this regulatory framework.  Reach out to us with any questions you may have.

Questions about this article? Reach out to our team below.