Is your borrower struggling financially? Have they fallen upon hard times? Do they need you to forbear on certain portions of the loan so that they do not fall behind on payments?
A forbearance may be the perfect solution for your borrower and you. However, if you are an unlicensed lender, before you rush into a forbearance you should consider whether the forbearance may impact your usury exemption for the loan.
Usury in California Law
Usury is defined as “the illegal action or practice of lending money at unreasonably high rates of interest.” In California, usury is capped at 10% per annum. The vast majority of Geraci clients fall under an exception to usury which allows them to charge interest above that 10% cap. A usury violation should be avoided. If you are found to be in violation of the usury limit, at a minimum, you could need to forfeit to the borrower all the interest on the loan (not just the usurious part.) Most clients know that they need to be concerned about usury at loan origination, but it is also important to evaluate it at any point that the loan terms are being changed.
Article XV of the California Constitution
Firstly, Article XV of California’s Constitution includes a usury exception for “any loans made or arranged by any person licensed as a real estate broker by the State of California and secured in whole or in part by liens on real property.”
California Civil Code Section 1916.1
What it means to be made or arranged by a real estate broker is better defined in California Civil Code 1916.1: “The restrictions upon rates of interest contained in Section 1 of Article XV of the California Constitution shall not apply to any loan or forbearance made or arranged by any person licensed as a real estate broker by the State of California, and secured, directly or collaterally, in whole or in part by liens on real property.” (Emphasis added.) This means that unlicensed lenders are exempt from usury so long as their loan or forbearance is arranged by a licensed California real estate broker.
But what does it mean for a loan to be arranged by a licensed California real estate broker? Under California Civil Code 1916.1, a loan or forbearance is arranged by a person licensed as a real estate broker when the broker:
- Acts for compensation or in expectation of compensation for soliciting, negotiating, or arranging the loan for another;
- Arranges a forbearance, extension, or refinancing of any loan in connection with that sale, purchase, lease, exchange of, or an improvement to, real property or a business; or
- Arranges or negotiates for another a forbearance, extension, or refinancing of any loan secured by real property in connection with a past transaction in which the broker had acted for compensation or in expectation of compensation for selling, buying, leasing, exchanging, or negotiating the sale, purchase, lease, or exchange of real property or a business. (Emphasis added.)
Thus, a loan or forbearance is arranged by a licensed California broker when the broker is paid, handles the negotiation process, arranges the forbearance of a loan secured by real property or negotiates a forbearance that is secured by real property in connection with a past transaction in which the broker was paid to participate.
Importantly, the term “made or arranged” includes any loan made by a person licensed as a real estate broker as a principal or as an agent for others, whether or not the person is acting within the course and scope of such license.
What does this mean for me?
An exception to usury is any loan (including any forbearance, extension, or modification) of a loan that is arranged by a licensed real estate broker and secured by real property. If an unlicensed investor chooses to forbear, modify, or extend a loan and charges points, fees, or otherwise increases the rate of interest there is an argument that these new amounts are usurious even if the underlying transaction was arranged by a licensed broker and therefore exempt at origination. Effectively, you can take an exempt loan and turn it non-exempt by changing its terms without a broker.
What should I do?
To avoid accidentally turning your loan into a non-exempt loan, you should consult with the Geraci Transactional Team before entering a forbearance. Our team can talk through the facts of your situation with you and determine whether the forbearance should be arranged by a licensed California real estate broker.