Usury is the act of charging an interest rate higher than the maximum rate the law allows. People often associate usury with loan sharks, but because the California law on usury is complex, many businesses and people can end up committing usury without meaning to. In California, usury is governed and defined by Article 15 of the California state constitution and by the state civil codes. This sets out the general usury rules and exceptions to those rules.
In California, people or businesses are allowed to contract for an interest rate up to 10 percent per year on loans made primarily for “personal, family or household purposes.” This percentage is based on the unpaid portion of the loan. So, if you take out a $1,000 loan for one year, and pay the entire loan back at the end of the year, your lender could charge you up to $100. However, if you pay off half the loan early, your lender can charge you only the full 10 percent interest rate on the remaining $500.
Loans made in California for home improvement, or to buy a home, are not treated as loans made for personal, household or family purposes. On these loans, lenders may charge an interest rate of either 10 percent, or 5 percent above the Federal Reserve Bank of San Fransisco rate, whichever is higher. For example, if the Federal Reserve Bank rate is 6 percent, your lender would be allowed to charge you an interest rate of 11 percent without being guilty of usury.
Lenders must use the Federal Reserve Bank rate that is in operation on the 25th day of the month in which the loan is agreed. If the loan is agreed after the 25th of the month, the lender must use the previous month's rate. Usury laws in California do not apply to licensed real estate brokers, who may charge higher interest rates as long as the loan is secured by real estate.
The basic California law limiting the interest rate that can be charged on a loan does not apply to lenders such as banks, credit unions or finance companies. Contracts that involve repayment over time – such as credit cards, retail installment loans or revolving accounts are not treated as loans and may also charge higher interest rates. According to the California state attorney general, credit cards may charge unlimited finance charges, even if the credit is used for personal, family or household purposes. If there is no agreement between the lender and the debtor as to the rate of interest, California law imposes a default rate of 7 percent a year.
Penalties and Restrictions
Loan agreements that do not state the full terms of repayment are subject to the default provisions in Section 1916 of the California Civil Code. The default rules state that interest rates can increase only once every six months, at a maximum increase of 0.25 percent each time. The maximum rate is capped at 2.5 percent above the initial rate. Knowingly and willfully violating the California limits on interest rates is punishable by up to five years in state prison. Debtor may claim up to three times the amount paid to any lender found guilty of usury. Contracts that fall under the usury laws and that require an interest rate greater than 12 percent may be found null and void, and therefore unenforceable.