Overview of Usury Laws
Whether your business is new or established, the chances are that you will at some point in time require a loan. Up until 1974, if you needed extra cash for your company, all you would have to do is find a lender who was willing to fund the loan. Unfortunately, once your loan terms were decided, you were stuck with them regardless of how high the interest rate was. Fortunately, both the federal government and the government of each state imposes regulations on the interest rates that lenders can impose. With a few exceptions, these regulations are referred to as usury laws. Usury laws are in place to protect borrowers from lenders who would otherwise charge exorbitant rates of interest.
As far back as 3000 B.C., usury laws have existed in various cultures. Throughout history, various groups—most notably the Catholic Church—have sought to regulate interest rates, but it was not until the Medieval period that usury laws began to take on the more modern forms of which we are now more familiar. Most modern usury laws limit the amount that lenders can charge borrowers in interest, but some states actually go so far as to set the minimum rate of interest rather than the maximum . Either way, the common goal of usury laws is to simplify the economy by reducing the opportunities for deception and betrayal of trust between the lender and the borrower. Even in today’s world, usury laws have a very real impact on commerce, as they affect the amount of money that lenders are willing to lend and dictate the amount of money that borrowers can afford to borrow.
In particular, usury laws play a role in private lending. In an economy where institutional lenders are becoming less and less willing to lend private lending is becoming an increasingly common alternative to borrowing from a bank. Being as risky a venture as it is, private lending relies even more heavily on usury laws than other types of borrowing because the interest rates on private loans tend to be higher and vary more dramatically than those of institutional loans. Since private loans involve individuals rather than banks, borrowers are often forced to place their hopes in the uncertain hands of someone who has no formal ties to the system.
What Are Private Loans?
Private loans are straightforward unsecured loans offered by private lenders (rather than banks, credit unions, or other traditional lenders). While private loans can be used for virtually any purpose, many people use them to cover large one-time expenses, such as weddings, vacations, and medical bills.
Private loans do not factor in a borrower’s income (although they do require a credit score) and are often easier to obtain than other types of loans. Having little to no impact on a borrower’s credit, private loans are often viewed as a possible option for persons in need of immediate financial assistance.
The most common types of private loans are personal loans and peer-to-peer loans. Personal loans operate through an online platform that will match you with the best offers available. Peer-to-peer loans are essentially crowdsourced loans where one makes a request to the public to fund a loan.
Depending on the circumstances, private loans can be incredibly advantageous. In some instances, they can be a better option for consumers than a credit card (realizing that each consumer’s financial situation is unique). However, consumers should fully research the costs of a private loan before borrowing, as interest rates can be nearly double that of a bank loan.
Private Loans and Usury Laws
Though usually thought of in the context of lenders such as banks or payday loan companies, usury laws also apply to private parties who make loans to individuals or businesses at interest rates exceeding the maximums allowed by the relevant state law. Under usury law, and the potential penalties that can be assessed, high-interest rate private loans can attract the attention of state and local regulators as well as the civil or criminal courts themselves.
Rates in excess of legal usury limits can make a loan unenforceable, dependent on regulation, or lead to civil or even criminal liability for the lender. Depending on the specific circumstances involved in a given lending transaction, including with respect to the specific underlying facts or local laws that may apply, a specific loan may still be valid.
How Usury Laws Apply to Private Loans
The federal government has established a number of regulations governing the predatory practices of lenders, however state laws vary as to how usury laws are implemented. For example, the state of Alabama sets its maximum interest rate at 25% for a borrower unable to obtain a loan from a state or federally charted bank, as well as for loans of less than one year. Arkansas’s maximum ceiling for lenders is 17.5% on loans under $10,000. Massachusetts’s usury laws are stricter than many other states, combing a fixed rate that varies by state or institution with a dymanic component which accounts for a consumer’s credit score, establishing a 20% ceiling for borrowers of lower quality credit. Alabama, Arkansas and Massachusetts are just three examples of widely varying state laws, Alabama having the most flexible and Arkansas and Massachusetts having some of the strictest in the country.
The most important aspect for private consumers to understand is that strict usury laws do not always extend to private lending agreements. The onus is on the private citizen to protect themselves against high interest rates by insisting on a written contract detailing the amount to be paid, with ascertainable details of all late fees, interest accrued, and whether the loan is subject to state usury laws or regulations. Even if a private lender were subject to usury laws set by the state, the laws typically would not apply to a small amount loaned due to the loan size.
How States Vary in Their Application
Violating usury laws can lead to serious consequences for lenders of private loans. In Texas, those penalties may be both civil and criminal. For example, if a homeowner borrows money at illegal interest rates, they are not required to pay back the principal amount or any interest on the loan. Thus, violating usury laws can financially benefit the homeowner at the cost of the lender. A party can sue to recover amounts paid to a lender as well as obtain a judgment for any amounts due.
Given that usury laws are enforced against illegal lenders, anyone who has made a loan at an illegal interest rate is liable for those penalties, regardless of whether they have collected on the loan in question . Also note that the statute of limitations for a usury claim is four years from when the loan was made. Inspiration Manufacturing, Inc. v. Hydrotech Systems, Ltd., 301 S.W.3d 383, 400 (Tex. App.—Dallas 2009).
There are also criminal penalties associated with violating usury laws. Usury is a form of theft, and any agreements entered into under usury laws are illegal and cannot be enforced in court. It is essentially a consensual agreement to engage in a crime. This is typically a Class A misdemeanor but may also be prosecuted as a third-degree felony if the loan in question is for at least $200,000.
Penalties for Disregarding Usury Laws
Whether you are borrowing money from family, friends, acquaintances or a commercial private lender, there are steps you can take to protect yourself when entering into a private loan transaction. If your interest rate is over 10% and you live in Washington State, Washington usury laws may apply. You can research Washington usury laws online. You can also contact an attorney of your choosing to get legal advice about what usury laws apply in your situation.
How to Protect Yourself as a Borrower
A common scenario involves a senior citizen lending money to a child or grandchild, with the full belief that the loan will be paid back as agreed. When things go awry and the family member fails to make payments, problems can arise. For such personal loans, family members should be warned against entering into usurious agreements. A recent case involved a $400,000 loan from a mother to her daughter with an interest rate of 10 percent. The interest rate was in excess of the 6 percent agreed to in a loan agreement even though it was common market interest rates for such loans were 10 to 15 percent. The lender alleged that the younger woman failed to pay the amounts due under the terms of the agreement, and sought a judgment stating that it had been breached. The Court found that the loan was, indeed usurious, and that it should be governed by the rate set forth in the agreement – not the common market rate. In this case, the lender did not recover $12,690 in interest charged over the course of the six year loan because the Court found the loan to be so tainted with usury that the whole loan was rendered void . A second scenario involved a case where a larger bank agreed to refinance a $5 million property owned by a couple with plans to build an office building on the site. Because of the volatility of the market, the bank was unwilling to approve the loan, but did not tell them, knowing that it could offer the couple much more money in the future at a better interest rate. The couple decided to turn to a private money lender. This lender charged a 200 percent annual interest rate, lending $1 million for 60 days. Three weeks after the loan was closed, the lender offered to allow the couple to refinance the loan at a significantly lower rate for 10 years. The couple signed the new loan, but when the couple defaulted, the lender sought to keep all of the interest paid, which amounted to $1,058,000. They argued that because the original loan was with such a high level of interest, the lower interest in the second loan should be rolled into the first loan, thus resulting in an interest rate of 200 percent for the duration of the second loan. The Court agreed that the first loan was by definition usurious and void for the entirety of the term, but that the agreement of the lower interest on a shorter term loan constituted an agreement to return part of the principal.