Usury – The General Rule and its Exemptions

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Employment law

Since 1979, the California Constitution, Article XV, section 1 has provided that the maximum rate which may be charged for money or goods which are for use primarily for personal, family or household purposes is 10%.  It further provides that for any other non-personal, family or household purposes, the maximum rate which may be charged is 10% or 5% plus the Federal Reserve Bank of San Francisco’s rate on the 25th day of the month preceding the date the contract was executed.

Exemptions From the Usury Law

However, there are numerous exemptions, some of which are specifically set forth in the Constitution, Article XV, section 1, and some of which the Constitution has authorized the Legislature to promulgate. Together, these include:

(1) Institutions in the business of lending money. These include banks, loan associations, credit unions, licensed pawnbrokers, personal property brokers and industrial loan companies. 

(2)  Loans made or arranged by a licensed real estate broker, which are secured in whole or in part by a lien on real property. The real estate broker need not be acting in his licensed capacity on behalf of a buyer or seller of real property; he is exempt, even if he is acting only in the capacity of a principal in the transaction.  However, a loan made or arranged by licensed real estate agent is not exempt. 

(3)  An evidence of indebtedness of $300,000 or more issued under a Corporate Securities Law qualification. 

(4)  A loan to a borrower who has total assets of at least $2 million.

(5)  Loans made by specified institutions who are authorized to act as trustees in a fiduciary capacity. 

(6) Licensed finance lenders.

The fact that certain loans are exempt from the general usury law does not necessarily mean that the lender may charge whatever interest rate he or she wishes.  Many of the usury exemption laws place a cap on the interest rate which may be charged under the statute providing the exemption.

As an example, a licensed pawnbroker may not charge or receive compensation at a rate exceeding the sum of 3% per month on the unpaid balance and a charge of $3 a month if the 3% a month charge is less than $3. Industrial loans are limited to 2% a month on loans up to $1,000 and 1% a month on the balance in excess of $1,000. The statute exempting loans secured by real property also contain detailed provisions for maximum charges on such loans.  However, these limitations do not apply in the event the loans exceed specified amounts – for instance, $2,500 or more for loans by licensed pawn broker, $5,000 for industrial loans, loans secured by first mortgages of $30,000 or more and loans secured by second mortgages of $20,000 or more.

The California Finance Lenders Law

This statute exempts many individuals and institutions from the usury laws.  The more common examples include (1) banks and similar institutions, (2) persons who make five or fewer commercial loans in a 12-month period, if the loans are not the main business of the lender and are only incidental to the lender’s principal business, and (3) a person who makes only one commercial loan in a 12-month period.

These are but a few of the exemptions under the Finance Lenders Law.  Many other individuals and entities are exempt from the usury law, as are many specified types of transactions, regardless of whether the individuals and entities engaging in them are themselves exempt.  See Financial Code sections 22050 et. seq.

Penalties for Violation of the Usury Laws

Because usury is against public policy, a lender’s good faith belief that a loan is lawful will not protect him from application of the penalties for engaging in a usurious loan transaction.  All interest charged under a usurious loan is null and void and a borrower need not pay it.  To the extent a borrower has paid usurious interest to the lender, the borrower may sue the lender to recover that interest so long as he does so within the relevant limitations period.

A borrower who pays usurious interest must sue to recover that interest withing two years of payment of that interest.  If the borrower sued to recover interest paid within one year of filing suit, he may recover three times the interest he paid.

The general rule is that a lender is entitled to recover the principal he has loaned, regardless of the usurious nature of the loan.  Many usurious loans are memorialized in writing.  A borrower’s failure to repay such a loan is a breach of a written contract.  The statute of limitations for bringing an action for breach of contract is four years.  If a lender files a breach of contract action more than two years but less than four years after a borrower defaults on the loan, the borrower may assert usury as an affirmative defense to the lender’s claims for interest.  That is because the two-year statute of limitations applies only to a claim for recovery of interest.  It does not apply to a defense against the lender’s claim for recovery of usurious interest.

There are exceptions to the general rule that a lender may recover the principal amount of the loan.  There are a few statutes which provide that the entire loan contact is void, and that the lender may not recover principal or interest.  The main one is the California Finance Lenders Law, which nullifies the entire loan agreement if the violation is willful.

The Law Office of William J. Tucker is familiar with the usury laws, and provides free initial phone consultations to borrowers and lenders who have issues concerning loan transactions. Feel free to Schedule an Appointment.