Hello everybody. At the time when interest rates on mortgages are at a near historic low, AOA members might find it surprising that I am devoting this article to a discussion of high interest rates, that is, usurious interest which exceeds the maximum rates California law allows.
But interest rates are not low for everyone, especially apartment owners who find themselves in desperate need to borrow money to pay their mortgages, property taxes, repairs, water bills and other carrying charges after their tenants stop paying their rent because they were laid off from work or are just gaming the system while insulated from eviction.
Those landlords are especially susceptible to very high interest rates charged by unscrupulous hard money lenders of second or third trust deed financing.
The good news for financially strapped landlords is if their loan transaction is usurious, all interest (not just the amount exceeding the maximum allowable amount), charged by the lender is forfeited.
My column this month will provide an overview of all types of loans, including those made to building owners, together with the corresponding allowable interest rate.
For any loan of money which is to be used primarily for personal, family, or household purposes, the maximum interest rate permitted by law is 10% per annum. This limitation is set forth in Article XV, Section 1 of the California State Constitution.
Loans used primarily for purchase, construction or improvement of real property are not subject to that 10% constitutional limitation.
Bank, Broker and Seller Carryback Loans
Certain types of loans do not have any interest limitation. Those made by banks, savings and loan associations, certain credit unions, and certain industrial loan companies are exempt from the usury laws. Thus, a bank may generally charge any interest rate which the market will bear.
Similarly, loans made by a real estate broker which are secured in whole or in part by a lien on real property are not subject to any maximum interest rate. Likewise, loans arranged by a real estate broker and secured by liens on real property are exempt from the usury laws.
Thus, if a real estate broker participates in the arrangement of a loan to an individual, and the loan is secured by a lien on real property, the general rule is that the lender may charge any rate he is able to induce the borrower to agree to. This is true even through the broker himself/herself did not make the loan.
For the broker exemption to apply, the loan must be made or arranged by a real estate broker and not merely a real estate salesperson. (Jones vs. Kallman, 199 C.A.3d 131) Individual lenders who seek to avoid the 10% interest limitation when their broker arranges the loan should ask to see the real estate agent’s license. If the license designates the arranger as a salesperson, the transaction will be subject to the usury limitation. If the license shows that the arranger is a broker, the exemption will apply.
The philosophy behind exempting loans made or arranged by brokers is that brokers are qualified by the State of California on a basis of education, experience and examination, and their licenses can be revoked or suspended if they perform acts involving dishonesty, fraud, or deceit. While a salesperson’s license may also be revoked or suspended for violation of ethical conduct, their education and training are not as great as that of a broker.
Surprisingly, loans which are made or arranged by attorneys are not exempt from the usury limitations. In Del Mar vs. Caspe, 222 C.A.3d 1316, the court held that only licensed real estate brokers, not licensed lawyers, could cause a loan to be exempt from the usurious limitations. If a lawyer also happens to be a licensed real estate broker, then the exemption from usury limitations would be applicable.
Promissory notes and trust deeds carried back by a seller are also exempt from the usury limitations on the theory that the seller never loaned any money to the buyer. It was simply a credit sale.
Also, modifications of such seller carry-back loans are exempt. In D.C.M. Partners vs. Smith, 228 C.A.3d 729, the court held that an extension of an originally exempt transaction of a promissory note secured by a deed of trust on real estate is not subject to usury when the loan is extended and the interest is increased to 15%. In that case, the buyer paid a portion of the purchase price by giving the seller a 10% note secured by the property. Before the note’s due date, the seller allowed the buyer an extension in exchange for an increase in the interest rate to 15%. The court held that the extension was exempt from the limitations.
For most loans other than those discussed above, a confusing formula prescribes the maximum interest rate as being the higher of 10% per annum or 5% per annum plus the Federal Reserve Bank of San Francisco’s discount rate prevailing on the 25th day of the month preceding either the date of executing the loan contract, or the date the loan is made, whichever is earlier.
Since the current discount rate (as of January 25, 2021) is 0.25%, adding 5% to the formula would allow a 6.25 maximum interest rate on these kinds of loans. Readers may ascertain the current discount rate for any given month at:
From time to time, customers purchase products or services from a retailer subject to an installment sale or an invoice showing that the balance is due within a stated period of time, typically 30 days. If payments are not made in accordance with the time limitations, finance charges are often added to the purchase price, such as 1.5% per month on amounts past due. In O’Connor vs. Televideo System, 218 C.A.3d 709, the court held that a purchase over time, or payments not made within the period due, are exempt from the usury laws under the “time-price” doctrine. That doctrine applies when property is sold on credit as an advance over the cash price. Since that type of transaction is a bona fide credit sale, it does not involve a loan subject to usurious limitation. Furthermore, the court in O’Connor held that the transaction was not usurious because the debtor had the opportunity to pay the amount due before any finance charge would be added.
Penalties for Usury
Here is the key question: If, the maximum allowable interest rate is 10%, but the lender charges 14%, does the lender only have to refund the overage? The answer is NO. The consequences for charging usurious interest are severe. The penalty for receiving a usurious amount is not just forfeiting the extra sum, but forfeiting all interest paid throughout the duration of the transaction:
“A transaction is usurious if there is a loan at greater than the legal rate of interest…When a loan is usurious, the creditor is entitled to repayment of the principal sum only. He is entitled to no interest whatsoever. The attempt to exact the usurious rate of interest renders the interest provisions of a note void. Interest payments that were made at the usurious rate should be credited against the principal balance in any action to collect on the note.” Hardwick v. Wilcox, 11 C.A.5th 975.
In other words, all payments made under a promissory note which provides for a usurious interest rate are applied to principal, not to whatever lower rate might have been the maximum allowable rate.
The Hardwick Court explained that the rationale of usury law is that society as a whole benefits by the prohibition of loans at excessive interest rates, even though both parties are willing to agree to them at the time the transaction is arranged. The usual principle of “freedom to contract” does not extend to usurious interest.
Also, a court might find that charging a usurious rate warrants a penalty of treble the amount of the usurious interest actually paid. Obviously, the amount of the penalty could be painful to the lender. (Anderson vs. Lee, 103 C.A.2d 24; West’s Annotated Civil Code, Section 1916-2.)
The earliest account of a usury prohibition is found in the Bible, Exodus 22: 24-25, where it says: “Neither shall ye lay upon him interest.” Different versions of the Bible have different translations. In England in 1545, King Henry VIII’s Parliament enacted a statute allowing interest payments of up to 10% on loans, with any higher rates constituting usury.
Numerous other countries restricted interest rates over the centuries, with the earliest laws prohibiting the assessment of any interest. The reason was that lawmakers felt that barring all interest would relieve common people from oppression by the rich.
Note to Attorneys
In California, the primary usury provision is set forth in Article XV, Section 1 of the California Constitution. Additional laws can be found in the Civil Code commencing with Section 1912. Lawyers should also note that Civil Code Section 1916-2 is only found codified in West’s Annotated Codes. Deerings does not recognize it as a valid codification.
Lawyers seeking to avoid the effect of usury laws might try to argue that the money was advanced as a joint venture, rather than as a loan, such that the “lender” might share in the profits or losses of the money which the “borrower” invests. Money advanced by a joint venture or partner is ordinarily exempt.
I venture to say that the pandemic has financially harmed every apartment building owner in California. If you find yourself as one of the unfortunate landlords strapped for cash and in desperate need of an immediate loan of money secured by a mortgage against your building, I hope this article will assist you in determining if the interest charged is allowed by law.
Dale Alberstone is a prominent real estate attorney who has specialized in real property and resident manager law for the past 40+ years. He is also a former arbitrator for the American Arbitration Association.
Mr. Alberstone has been awarded a 5-Star AV rating from Martindale-Hubbell, the 125-year-old national rating service of attorneys. A 5-Star AV rating is the highest possible rating bestowed and reflects an attorney who has reached the heights of professional excellence and who is recognized for the highest levels of skill and ethical standards.
The foregoing article was authored on February 1, 2021. It is intended as a general overview of California law only and may not apply to the reader’s particular case. Readers are cautioned to consult a lawyer of their own selection with respect to any particular situation.
Questions of a general nature are warmly invited. Address correspondence to Dale S. Alberstone, Esq., ALBERSTONE & ALBERSTONE, 269 S. Beverly Drive, Suite 1670; Beverly Hills, California 90212, or phone: (310) 277-7300.