Many people wrongfully believe they can charge whatever amount of interest the market with bear. Unfortunately, that is not generally the case. In most circumstances, a non-exempt lender is restricted to collecting ten percent (10%) per year on a loan, even if the borrower begs and pleads to pay a higher rate of interest. My office routinely deals with victims of usurious loans, both borrowers and lenders…. yes, even lenders can be victims when they unknowingly loan money at a usurious rate because the penalties for usury can be significant. As we have seen a huge increase in these types of cases, here is an overview of California’s law on interest rates, loans, promissory notes, and usury. In short, however, non-licensed lenders at this time can only charge ten percent (10%) interest a year on a Loan, and if the interest rate is higher than it probably is usurious.

What is Usury and What Makes a Loan Usurious?
Usury is the charging of interest in excess of that allowed by law. California courts have held that “interest” includes anything of value that is received directly or indirectly by the lender from the borrower regardless of the nature or form of the consideration (e.g., fees, bonuses, commissions, and other miscellaneous charges).

California’s usury law, set forth in Article XV Section 1 of the California Constitution and codified in 10 different code sections, limits the amount of interest which can be charged on any loan, or forbearance, of money. A “forbearance” is the refraining from taking legal action to enforce a debt, right, or obligation. Oftentimes, a forbearance would describe the lender’s agreement to extend the due date on an existing loan in return for an increased interest rate.
Pursuant to California law, non-exempt lenders (the average individual) can charge a maximum of: (i) 10% interest per year (.8333% per month) for money, goods or things used primarily for personal, family or household purposes and (ii) for other types of loans (home improvement, home purchase, business purposes, etc.), the greater of 10% interest per year, or 5% plus the Federal Reserve Bank of San Francisco’s discount rate on the 25th day of the month preceding the earlier of the date the loan is contracted for, or executed. In other words, the general rule is that a non-exempt lender cannot charge more than 10% per year (.8333% per month), unless there is an applicable exemption.

It is the multitude of exemptions to California’s usury law that are strewn throughout various code sections (including the Civil Code, the Financial Code, the Insurance Code, etc..) that make California’s usury laws very complicated and difficult to understand. To complicate matters even more, Federal laws and regulations may also be applicable.

Multiple California code sections govern the legal rate of interest that may be agreed upon including:

1. CALIFORNIA CIVIL CODE SECTION 1917-1917.006
2. CALIFORNIA CIVIL CODE SECTION 1917.060-1917.069
3. CALIFORNIA CIVIL CODE SECTION 1917.160-1917.168
4. CALIFORNIA CIVIL CODE SECTION 1917.610-1917.619
5. CALIFORNIA COMMERCIAL CODE SECTION 9201-9208
6. CALIFORNIA CORPORATIONS CODE SECTION 25116 – 25118
7. CALIFORNIA FINANCIAL CODE SECTION 22000-22064
8. CALIFORNIA GOVERNMENT CODE SECTION 5900-5909

So, When is a Loan Usurious?
A loan will be deemed to be usurious when the interest charged exceeds the maximum amount prescribed by law. The lender’s knowledge is immaterial. The plaintiff need not prove intent, and failure to know the law is no defense. In fact, even if the borrower proposes a high interest rate and drafts the note, a non-exempt lender will still be held liable for collecting on a usurious loan if the annual interest rate exceeds 10%.

Are There Any Defenses to a Usury Claim?
Absent an exception to the usury law (discussed below), there really are no defenses to a usury claim. Usury is usury. The lender either has, or has not, charged an illegal interest rate. For this reason, usury claims (even those that allege fraud) are very difficult to defend. As stated above, ignorance of the law is no defense. Likewise, even where the borrower pleads for a loan, sets the interest rate, drafts the promissory note, and both willingly and knowingly pays a usurious interest rate, the lender is still liable. However, it is possible through the agreement of both the lender and the borrower to correct a usurious loan, or forbearance. The California appellate court has held that a usurious agreement may be purged of its usury if the lender and borrower voluntarily and with full knowledge of the usurious nature of the initial loan enter into a new agreement and the lender credits the borrower with the amount of usurious interest paid in the previous transaction.

So, What Happens if a Loan is Deemed Usurious?
If a loan is deemed to be usurious, the originator of a usurious loan may be subject to severe civil penalties. The borrower is generally entitled to the following cumulative remedies:

1. the borrower can bring an action for money damages for ALL the money he has previously paid during the two-year period prior to the filing of an action (not just the usurious amount);
2. the borrower can seek damages equal to three times the interest paid during the 12 months prior to the filing of a lawsuit, and after filing of the lawsuit;
3. the borrower can get a judgment to cancel all future interest that will become due for the remainder of the term of the loan;
4. in appropriate cases, where the lender’s conduct is oppressive, fraudulent or malicious, the borrower may be able to recover punitive damages.

The result is that a usurious loan may turn into an interest free loan with potentially costly damages and a potential for criminal liability. Any willful violation of the usury laws may also be a violation of Business & Professions Code § 17000, et. seq., which would expose the lender to criminal liability. If a court were to find that the lender knowingly, or willfully, charged a usurious interest rate, the lender may be found guilty of “loan sharking” which is a felony punishable by up to five years in jail.

What about the principal? Even if a loan is deemed to be usurious, the lender is still entitled to receive the principal back and to retain any security for the loan.

What Are Some of the Exemptions from California’s Usury Law?
The remainder of this article will set forth briefly some of the exemptions to California’s general usury law.

1. Licensed Lending Institutions Are Generally Exempt from Usury.
   Most licensed lending institutions engaged in the business of making consumer and/or commercial loans such as banks, savings and loan, credit unions, finance companies, and even pawn brokers are exempt from California’s usury laws. See, California Financial Code §5102, §7675 §15000, §21000, §21200, §22002, §22009, and §22303; Home Owners Loan Act of 1933, 12 U.S.C.A §1464(5)(c)(4)(B) and the Building and Loan Association Act of 1931 (as amended).
2. Loans Secured by Real Estate that are “Made or Arranged” by a Licensed Real Estate Broker MAY also be Exempt from Usury.
   Loans that are “made or arranged” by a California-licensed real estate broker and secured in whole, or in part, by a lien on real property MAY be exempt from California’s usury law if originated and negotiated properly. See California Civil Code §1916.1. Pursuant to California case law, the level of broker participation required to qualify for the exemption is not extraordinarily high but has been increased over the years. Typically, to qualify for the broker arranged exemption to the Usury law, the real estate broker must do more than simply perform escrow activities on a loan that has already been negotiated and signed by the lender and borrower. To what extent, goes beyond what can be set forth in this article.
3. Loans Used to Purchase, Build or Improve Real Property MAY be Exempt.
   Real estate loans acquired to purchase real estate, construct a home or building, or to make improvements are sometimes not considered loans for personal, family or household purposes; typically a non-exempt lender must limit the interest collected to the greater of: (1) 10% per year, or (2) 5% plus the Federal Reserve Bank of San Francisco’s discount rate on the 25th day of the month preceding the earlier of the date the loan is contracted for, or executed. However, if the loan is “made or arranged” by a licensed real estate broker, as described above, then the lender may be exempt from the usury limits.
4. Seller Financing – Seller Carryback Loans Are Exempt from Usury
   In California, when a seller of real estate finances the purchase for the buyer with a note secured by a deed of trust, the financing is commonly referred to as a seller carry back loan. When a seller finances a real estate purchase, the seller is acting as the bank or lender. Oftentimes, a seller will offer to carry back all, or a portion, of the purchase price in order to get the home sold, especially if the banks will not offer to lend the total amount of financing needed to fund the desired purchase price.In California, some courts have held that a seller carryback loan (a.k.a. purchase money debt, Time Price Doctrine) is not a loan, but a sale on credit. As a credit sale debt, a seller can carryback a note, secured or unsecured, and such may not be considered a loan subject to California’s usury laws.
5. Time payment contracts a.k.a. retail installment contracts and revolving accounts MAY also be exempt from the usury law.
   The Unruh Act set forth in California Civil Code §§1802.1, 1802.2, 1802.6 governs the financing of consumer goods (e.g. appliances, flooring, etc…) under a retail installment sales contract under which a seller finances the purchase of its consumer goods or services and the buyer agrees to pay in installments. The California Supreme Court recently held that if a bona fide retail credit sale is later restructured through the mutual agreement of the lender and borrower/purchaser, the credit-sale debt-restructuring settlement will be exempt from usury. Similarly, the Automobile Sales Finance Act (Civil Code §§2981 et. seq.) regulates the maximum finance charges that automobile sellers may charge, although third-party financing arranged by the automobile seller is not subject to the Automobile Sales Finance Act.
6. At present, at least in California, credit cards (Visa, MasterCard, Amex) are exempt from the usury law.
7. Licensed pawnbrokers are exempt from the usury law; however, the California legislature has prescribed maximum interest rates pawnbrokers can charge.
   California Financial Code § 21000 defines a pawnbroker as any person “engaged in the business of receiving goods, including motor vehicles, in pledge as security for a loan.” Financial Code § 21000 further provides that the maximum interest rate pawnbrokers may charge is 2.5% per month. A personal property broker, someone who lends money in exchange for a security interest in personal property, is subject to the same limits as a pawnbroker. The maximum interest rates for personal property brokers are essentially the same as those for pawnbrokers. See California Financial Code §22009 and §22303.A Loan Made to a California Business (corporation, or limited liability company) that has $2,000,000 or More in Assets OR that is for $300,000 or More MAY be Exempt from California’s Usury Law IF:
   (a) the lender and the borrower (or any of its officers, directors or controlling persons) have a pre-existing personal, or business relationship; or
   (b) the lender and the borrower by reason of their own business and financial experience, or that of their professional advisors, could reasonably be assumed to have the capacity to protect their own interests in connection with the transaction; and
   (c) the loan is not guaranteed by any individual, a revocable trust, or a partnership that has a general partner. See California Corporations Code §25118; and
   (d) the purpose of the loan is primarily for something other than personal, family, or household purposes.
   Minimum-Interest Rules

Definition of Minimum-Interest Rules
Minimum-interest rules refers to a law that requires that a minimum rate of interest be charged on any loan transaction between two parties. The minimum-interest rules mandate that even if no rate is charged by the lender, an arbitrary rate will be automatically imposed upon the loan. The minimum-interest rules are at least partly intended to prevent excess gifting between taxpayers via intra-family loans with no or below-market interest rates. The Rule of Thumb is that interest should not be below the minimum of the Federal Reserve Bank of San Francisco’s discount rate on the 25th day of the month preceding the earlier of the date the loan is contracted for, or executed, which at the time of the writing of this article would be approximately Three Percent (3%).

Breaking Down Minimum-Interest Rules
Minimum-interest rules are fairly complex and have been subject to numerous changes and modifications. There are separate rules for personal and commercial loans and sales of property that are financed by the seller.

Lenders could be required to report with their taxes any interest they received in excess of the principal loan amount.

Potential Exceptions to Minimum-Interest Rules
According to section 7872 or the Internal Revenue Code, there are some exceptions to the rules for direct gift loans between individuals if the amount is below $10,000. However, this exception does not apply to gift loans made for the acquisition of income-producing assets.

Gift loans up to $100,000 might also qualify as an exception to the rules under particular circumstances. The loan must be granted to a relative or child for the purpose of buying a home or launching a business. Furthermore, the borrower’s net investment income must be $1,000 or less for the year.

If the total outstanding balance in gift loans exceeds the limits during the year, then the loan will be subject to interest rules. If the net investment income of the borrower exceeds the $1,000 threshold, imputed interest rules would apply but only on their net investment income.

There are other instances where the providing of funds could be classified as a loan that may fall within interest rules. Funds granted to senior continuing care facilities as part of the fees paid for ongoing care may qualify as a loan if it exceeds certain limits and is considered refundable.

Imputed interest can be avoided on other loans as long as the current federal interest rate is applied to them. The rates are set monthly by the Internal Revenue Service. For term loans, the rate that should be applied is the federal rate that was set on the day the loan was made. For loans that have a term that is less than three years, the short-term rate would apply. Mid-term rates would apply on loans with terms of three to nine years. Loans with greater than a nine-year term, the long-term rate would apply.

Conclusion
In California, a simple loan can turn into a disastrous event, even if there was no intent to violate the usury laws. Before borrowing, or more importantly, lending money consider the impact of the usury laws on the transaction and consult a licensed California attorney familiar with California’s usury and finance laws as there are other laws that may come into play. A little bit of planning and forethought can prevent hefty legal bills and headaches. If you are a borrower, you should examine all loans received from non-financial institutions to determine whether the usury laws can be used for your economic benefit. It is important to act quickly, however, as the statute of limitations is just two (2) years, and just One (1) year for those seeking treble damages.

~ Attorney Gregory R. Beyer

If you have additional questions about California’s usury law, loans, or promissory notes, or need us to prepare or review loan documentation, then we can help.