Usury Exemption Q & A
Q 1. What is “usury”?
A “Usury” is the act of charging a rate of interest in excess of that permitted by law. In California, as well as many other states, unless exempt, lenders are not permitted to charge interest above the legal rate. Some states have a specific interest rate limit. California, on the other hand, has what’s known as a floating usurious interest rate for some types of transactions, and a fixed rate for others. Charging more than the maximum allowable rate would be usury (Cal. Const. art. XV, ß 1). The usury law applies to any person, association, copartnership, or corporation, unless exempt, that charges a legally excessive rate of interest (Cal. Const. art. XV, ß 1).
Q 2. Where can I find California’s usury law?
A California’s restrictions on rates of interest–usury–are contained in Section 1 of Article XV of the California Constitution and Civil Code Section 1916.1. In addition, the California courts have further elaborated on the restrictions and exemptions.
Q 3. What is the maximum legal interest rate under the California’s usury law?
A The California Constitution states:
the maximum interest rate that can be charged on a loan that will be used for personal, family or household purposes is 10% per year, and
the maximum rate for loans for any other purpose is either
(a) 10% per year or
(b) 5% per year plus the “federal discount rate” prevailing on the 25th day of the month preceding the earlier of the date the contract to make the loan was signed or the date the loan was made, whichever occurs sooner.
As used in this memorandum, “federal discount rate” means the rate of interest established by the Federal Reserve Bank of San Francisco for advances to member banks.
(Cal. Const. art. XV, ß 1.)
Q 4. Are loans used to purchase, build or improve real property considered to be for “personal, family or household purposes” under the usury law?
A No. Real estate loans are considered to be for other purposes and are governed by the second part of the answer to Question 3.
Q 5. Is the California usury law applicable to seller financing–that is, notes secured by a deed of trust carried back by sellers of real property?
A No. The California courts have determined that a seller carrying back a note on the sale of the seller’s property can charge any agreed-upon interest rate and is not subject to the usury laws. To constitute usury there must be a “loan or forbearance of money.” With seller financing there is no borrowing or lending or forbearance of money; it is considered a sale on credit rather than a loan. The seller could just as easily have sold the property at a higher price. Interest in the context of seller financing is sometimes referred to as a “time-price differential.” (See Verbeck v. Clymer (1927) 202 C. 557; Boerner v. Colwell Co. (1978) 21 C.3d 37.)
Q 6. Does the usury law apply to all lenders?
A No. Most institutional lenders are exempt from the usury law (Cal. Const. art. XV, ß 1).
Q 7. What types of institutional lenders are exempt from the usury law?
A Banks, savings and loan associations, building and loan associations, industrial loan companies,credit unions, pawn brokers, personal property brokers and certain non-profit agricultural cooperative associations are all exempt from the California usury law. The legislature retains the power to regulate the interest rates of such lenders by statute,however, and they are so regulated. (Cal. Const. art. XV, ß 1.)
Q 8. Are licensed real estate brokers also exempt from the usury law?
A It depends on whether the real estate broker has “made” the loan or “arranged” the loan. The Constitution states that the usury law does not apply to loans or forbearances made or arranged by any person licensed as a real estate broker by the state of California and secured, directly or collaterally, in whole or in part by liens on real property. These types of loans may bear any rate of interest agreeable to the borrower and the lender. (Cal. Const. art. XV, ß 1; Cal. Civ. Code 1916.1.)
Q 9. In order to come under the exemption for “arranging” a real estate loan, what is the real estate broker required to do?
A To fall within the real estate broker exemption for “arranging” the loan, the broker must actively participate in putting the loan transaction together. The 2004 case, Gibbo v. Berger held that when the real estate broker was the escrow officer who complied with the escrow instructions, prepared the loan documents using preprinted forms, obtained a title insurance policy, and disbursed the funds–all for a fee of $100–those activities did not constitute “arranging a loan.” (Gibbo v. Berger (2004) 123 Cal. App. 4th 396.)
On the other hand in Del Mar v. Caspe, the real estate broker, who was also a lawyer, conducted title searches, calculated the outstanding principal owed by the borrower, set the interest rate on additional loans to the borrower, prepared loan documents, and discussed those documents with the lender and borrower. The court held that those activities did constitute “arranging a loan.” (Del Mar v. Caspe (1990) 222 Cal. App. 3d 1316.)
Thus, the broker must do more than simply “rubber stamp” a loan that has already been negotiated and executed by the borrower and the lender.
In addition, Civil Code Section 1916.1 states that the broker must be acting for compensation or in expectation of compensation; therefore, a fee should be charged by the broker for arranging the loan to make sure that the loan will be exempt from the usury laws.
Q 10. Must a broker making the loan with the broker’s own funds also be performing some other licensed activity in order for the exemption to apply?
A No. Civil Code Section 1916.1 states that the term “made or arranged” includes any loans made by a person licensed as a real estate broker as the principal or as an agent for others whether or not the person is acting within the course and scope of such license.
However, the exemption doesn’t apply if the real estate broker is only the borrower. (Winnett v. Roberts (1986) 179 Cal. App. 3d 909.)
Q 11. Does the usury exemption apply to loans secured partially by real property and partially by personal property?
A Yes. The loan must be “secured in whole or in part by liens on real property ” (Cal. Const. art. XV, ß 1; Cal. Civ. Code 1916.1) (emphasis added).
Q 12. Does the usury exemption apply to loans secured by personal property alone?
A No. Interest on loans, secured solely by personal property, in excess of the legal limit would constitute usury. The Constitution states that loans must be “secured in whole or in part by liens on real property.” Thus, a loan secured solely by personal property would not satisfy this provision of the law. (Cal. Const. art. XV, ß 1.)
Q 13. If a broker-arranged loan is secured by a collateral assignment of the borrower’s interest as a beneficiary on an existing trust deed note, rather than secured directly by a lien on real property, does the exemption still apply?
A Yes. Civil Code Section 1916.1 states, “The restrictions upon rates of interest contained in Section 1 of Article XV of the California Constitution shall not apply to any loan or forbearance made or arranged by any person licensed as a real estate broker by the State of California, and secured, directly or collaterally, in whole or in part of liens on real property” (emphasis added).
Thus, the broker exemption extends to loans secured collaterally by liens on real property as well as to liens directly secured by such property. The exemption also applies to loans secured by mortgages and installment land contracts.
Q 14. Civil Code Section 1916. 1 states that the usury exemption applies to loans and forbearances. What is a forbearance?
A A “forbearance” is defined as the act of refraining from taking legal action to force a borrower to pay a note that is due. For example, a lender’s agreement to extend the due date on an existing trust deed loan in return for an increased interest rate would be a forbearance. (See Black’s Law Dictionary; Merriam Webster’s Collegiate Dictionary.)
Q 15. Does the real estate broker exemption apply to loans made or arranged by a licensed real estate salesperson?
A No. The exemption covers only a licensed real estate broker. Therefore, if a salesperson wants to use the exemption he or she must make or arrange the loan through a licensed broker. The usury exemption applies only if the real estate broker is actively engaged in negotiating and consummating the transaction.
For example: A loan with an excessive interest rate–higher than permitted by the usury laws– was negotiated by a real estate salesperson who was in a partnership with a real estate broker. The broker set the terms and interest rate for the loan and reviewed the documentation; all other activities relating to the loan were performed by the salesperson. The salesperson received all the commission except for a portion retained by the partnership for overhead expenses. The court held that this activity was sufficient for the loan to be “arranged” by the broker and for the loan to be exempt from the usury laws. (Jones v. Kallman (1988) 199 Cal. App. 3d 131.)
Q 16. Are there any limitations on the amount of fees or points that can be charged by the real estate broker/lender on a loan that comes under the broker exemption from usury?
A Yes, but only on first trust deed loans of less than $20,000, or junior trust deed loans of less than $10,000. With respect to these so-called “small loans” the maximum amount of commission that the broker can charge for arranging the loan, or, alternatively, the maximum amount of fees and points that the broker can charge for making the loan, are 5% of the principal amount on first trust deed loans of less than three years, 10% on first trust deed loans of three years or more, 5% on junior trust deed loans of less than two years, 10% on junior trust deed loans of two to three years and 15% on junior trust deed loans of three years or more. (Cal. Bus. & Prof. Code ß10242.).
[Note: See ß 10242.5 for restrictions on late charges, ß 10242.6 for restrictions on prepayment charges which apply not just to small loans, and ßß 10244, 10244.1 for restrictions on balloon payments.]
Q 17. Is a usurious loan completely void and unenforceable against the borrower?
A No. A usurious loan is not totally void; the lender is still entitled to receive payment of the principal amount of the loan. A borrower who has made a usurious loan can bring an action for damages to collect the past interest he has paid. Thus, the borrower does not have to pay the interest portion of the debt up to the maturity date. (See Haines v. Commercial Mortg. Co. (1927) 200 C. 609; Teichner v. Klassman (1966) 240 Cal. App. 2d 524; Rochester Capitol Leasing Corp. v. K & L Litho Corp. (1970) 13 Cal. App. 3d 697.) However, the lender is entitled to interest at the legal rate from the date of maturity of the loan until the date of the judgment of the case (Epstein v. Frank (1981) 125 Cal. App. 3d 111.)
in addition, the borrower may be able to recover penalty damages equal to three times the interest paid during the one year period immediately prior to the filing of the action (Stock v. Meek (1950) 35 Cal. 2d 809).
It should be noted that the borrower can only recover interest paid during the two years preceding the filing of the complaint because of a two-year statute of limitations (Stock v. Meek (1950) 35 Cal. 2d 809).
Q 18. If a lender brings an action to enforce the debt represented by a usurious loan, can he or she recover anything?
A If a borrower refuses to pay a usurious debt and the lender sues, the lender can recover only the principal. A usurious loan is not totally void; the lender is still entitled to receive payment of the principal amount of the loan. However, the lender is entitled to interest at the legal rate from the date of maturity of the loan until the date of the judgment of the case (Epstein v. Frank (1981) 125 Cal. App. 3d 111.)
Q 19. Can the beneficiary on a usurious loan secured by a trust deed foreclose on the property securing the loan if the payments are not made by the borrower?
A It depends. The beneficiary cannot declare the debt due because of a non-payment of interest, but the beneficiary can still declare the principal debt due and enforce the security because of a non-payment of principal.
Q 20. Does the two-year statute of limitations mentioned in Question 17 also apply to a lender bringing an action to collect the debt or enforce the security?
A No. The two-year statute of limitations only applies when the borrower commences the action against the lender. In other words, if a lender seeks to enforce his security on a usurious loan the borrower can raise the defense of usury and can recover all of the interest he has paid on the debt regardless of when the loan originated. This past interest paid can then be applied against the unpaid principal.
Q 21. Does the California usury law apply to loans made by federally licensed lenders?
A Generally not. In fact, certain federal loans are not even under the jurisdiction of the California usury law at all. For example, VA and FHA lenders are not governed by California usury law and the lender can charge any rate of interest, subject only to limitations imposed by those agencies. Furthermore, federal lenders are probably exempt under the usury laws. (See Question 7.)
Q 22. Where can readers get more information?
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