What Is the Legal Rate of Interest?
Let me explain the legal rate of interest directly: it's the highest interest rate that can legally be charged on any debt, and lenders must stick to it. This applies to all kinds of debt, but remember, some types—like payday loans—might have a higher legal limit than others, such as student loans. The whole point is to stop lenders from hitting borrowers with outrageous interest rates.
Key Takeaways
- The legal rate of interest is the highest rate of interest that can be legally charged on any type of debt.
- Certain types of debt may carry a higher legal rate than another.
- The limits are set to prevent lenders from charging borrowers excessive interest rates.
- An interest rate that exceeds the legal rate of interest is classified as usury, for which there are stiff penalties in most states.
- Each state sets a legal rate of interest and usury rates through their respective laws.
Understanding the Legal Rate of Interest
If an interest rate goes over this legal limit, it's usury, and most states have tough penalties for that, including fines or even losing the principal and interest. You should know that the legal rate also acts as the top rate enforceable in court for any legal claim. In the U.S., states handle their own interest rate laws—Congress hasn't gotten too involved, though collecting interest violently is a federal crime.
How the Legal Rate of Interest Is Applied in Different Jurisdictions
Each state sets its own legal rate through laws. For instance, New York adjusts its rates quarterly, while Delaware ties it to 5% above the Federal Reserve rate, so it can change. States also have general usury limits that might be higher, like New York's 16% for civil usury and 25% for criminal. If you're a bank or financier operating in a state, you're bound by that state's legal rate.
Special Considerations for the Legal Rate of Interest
There are exceptions where lenders can charge more than the legal rate. You might waive protections when applying for financing, and lenders often require agreements allowing higher rates—it's in the terms of service, so agreeing to it overrides the legal protections, even if you claim you didn't fully understand. Lenders can also skirt limits by incorporating in states with lax usury laws, like Delaware or South Dakota. Credit card companies charge based on their incorporation state, not where you live, and nationally chartered banks do the same.
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