What it means
The idea of limiting interest is very old, and it appears in legal and religious traditions across many cultures. Modern usury laws are less about banning interest and more about setting a ceiling on the rate, so borrowers are not trapped by unaffordable debt.
The ceiling is usually expressed as an annual percentage. In the United States, usury limits have traditionally been set by individual states, and the figures differ from one state to the next.
Some states set a single cap for most loans, while others set different caps for different types of loan or allow parties to agree any rate in writing. Because the rules sit at state level, a lender operating across states needs to know which law applies to each loan.
Many kinds of lending are exempt or treated differently. Federal rules allow certain banks to charge the rate permitted in their home state even when lending to customers elsewhere, and business loans above a set size are often outside the limits.
This is one reason the same lender can charge very different rates to different customers in different places. When a loan breaks a usury law, the consequences depend on the jurisdiction.
The lender may have to give up the interest above the cap, give up all the interest or, in severe cases, lose the right to collect the loan principal. Borrowers who rely on a usury defence must usually raise it in court, since the loan does not become void on its own.
For finance teams, usury laws matter when they borrow, lend or structure fees. Fees, charges and interest on late payments can sometimes be counted towards the rate when checking whether a cap has been breached.
Careful legal review is wise before a company writes a loan agreement that charges a high rate, particularly for consumer lending. Other legal systems take different approaches.
Some countries set caps on credit card or payday lending rates, while others rely on disclosure rules instead. Islamic finance applies a religious prohibition on riba, which is a broader principle than a rate cap, and sets up products that avoid charging interest altogether.
In practice
Real-world examples.
Example
A small business borrows $50,000 from a private lender at 30% a year. The state caps the rate at 16% for loans of that size, so the borrower's lawyer argues that the loan is usurious and the lender may lose some of the interest.
Example
A bank that issues credit cards from a state with no rate cap lends to customers in many other states. Federal rules allow it to charge its home state rate, so state usury caps elsewhere do not stop it.
Example
A start-up founder lends $100,000 to her own company at 12% a year. Her accountant checks the state limit and records the loan agreement in writing, so there is no doubt that the rate was agreed and is lawful.
Formula
Calculation
Excess interest = (rate charged - legal cap) x principal x years
Suppose a lender gives a $20,000 loan at 24% a year in a place where the legal cap is 18%. The rate above the cap is 24% - 18% = 6%. The excess interest in one year is 0.06 x 20,000 = $1,200. If the law requires the lender to forfeit the excess, the lender can collect only 0.18 x 20,000 = $3,600 of interest for the year instead of $4,800.Case study
Seen in the real world.
Ironbridge Capital is an illustrative, fictional lender that makes short-term loans to small shops. It charges a monthly fee on top of interest, and its loans work out to an annual cost of 32%.
A shop owner challenges the loan in court, arguing that the state's cap is 20% once fees are included. The court agrees that the fees count as interest for this purpose, so the loan breaks the cap.
In this illustrative story Ironbridge has to refund the interest above the cap on 200 loans, which comes to $410,000, and it redesigns its products to stay under the limit. The company's finance director learns that legal review of fees is as important as review of the stated rate.
Watch out
Common mistakes.
- Looking only at the stated interest rate, when fees and charges may count towards the limit.
- Assuming one national cap applies, when limits often differ by state, by loan type and by the lender.
- Thinking a usurious loan is automatically cancelled, when the borrower usually has to raise the point and the penalty depends on local law.
Questions
People also ask.
Do usury laws apply to business loans?
Often they do not apply in the same way, because many places exempt larger commercial loans or let businesses agree any rate in writing.
What is the difference between usury laws and a usury rate?
Usury laws are the rules, and the usury rate is the maximum interest rate those rules allow.
Why do credit cards often charge more than state caps?
Federal rules let national banks charge the rate allowed in their home state, which can be higher than the cap in the customer's state.
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