Legal Limits on Interest Rates for Loans and Credit

All U.S. states have passed laws known as usury laws, that define maximum lawful interest rates for loans. These laws were passed in order to protect consumers and to prevent loan sharking, exploitative lending practices often associated with criminal enterprises.

A loan that charges an unlawfully high interest rate may be referred to as a usurious loan.

Perform Due Diligence Before Lending Money

If you are making a loan or issuing credit that will carry interest, make sure that you investigate your state's usury laws and confirm that the interest rate you're charging is lawful. You should not assume that an interest rate charged by a commercial lender or credit card company will be a lawful rate, as those lenders may be exempt from usury laws that will apply to you.

If you are uncertain of your state's maximum interest rate, you can include a clause that provides for interest "at the maximum rate permitted by" the laws of your state. However, that clause may scare off a prospective client or customer. Also, if and when you want to collect interest in a loan or overdue account you will still need to determine what rate you may legally charge.

Common Usury Law Restrictions

Among possible provisions in usury laws, states may impose:

  • Different Rates for Different Types of Loan: Usury laws may define different maximum interest rates depending upon the nature of the loan. For example, an unsecured personal loan may have a different maximum interest rate than a loan made for the purchase of real estate through a mortgage or land contract.

  • Different Rates for Different Types of Creditor: States may allow certain classes of creditor, most notably financial institutions, to charge different and higher interest rates than may be charged by other businesses or individuals.

  • Restrictions on Compounding Interest: Usury laws may require a lender to charge only simple interest (interest only on the principal balance of the loan), as opposed to allowing compound interest (interest on both the unpaid principal balance and any accrued interest).

Consequences of Violating Usury Laws

Although state laws vary significantly, and some states will impose lesser or greater penalties based upon the amount to which an interest rate exceeds the maximum legal rate, common consequences of usury law violations include:

  • Application of All Payments to Principal: Some states will treat all payments made under a usurious loan as being made toward the principal balance, effectively transforming the loan into an interest-free loan.

  • Civil Liability: It may be possible for a borrower to sue the lender for damages, potentially including any excessive amount of interest paid and other economic damages. In some states, a borrower may be able to seek punitive damages. A lender who has issued multiple usurious loans may be targeted under racketeering laws, which may provide for significantly increased damages awards to borrowers based upon their establishing a pattern of misconduct by the lender.

  • Regulatory Action: When businesses charge unlawful interest rates, they may be investigated by a government agency such as a state attorney general's office, and may be .

Although rarely prosecuted as a crime, many states do have criminal statutes that may apply in usury cases, particularly where a very high interest rate is charged.

Copyright © 2016 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing by the author of the article you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.

This article was last reviewed or amended on Apr 6, 2018.