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Monetary Interest Rates for Policy

The Legal Rate of Interest Defined

By Adam Hayes

Updated January 14 2021

Review by Eric Estevez

What is the Legal Rate of Interest?

The legal rate of interest is the most high rate of interest that can be legally charged on any type of debt, and to which a lender must conform. This rate is applicable to all types of debt, although certain types of debt may be subject to a higher legal rate than others. For example, the legal amount for a payday lender could be higher than the legal limit for a student loan. The limit is set to prevent lenders from charging borrowers excessive interest rates.

Important Takeaways

The legal rate of interest is the maximum amount of interest which could be legally charged on any type of debt.

Certain types of debt could have a higher legal rate than other.

The limits are set to stop lenders from charging customers excessive interest rates.

An interest rate that exceeds the legal rate of interest is classified as usuary, and for this there are severe penalties in the majority of states.

Each state sets a legal rate of interest as well as usuary rates through their respective laws.

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Understanding the Legal Rate of Interest

A rate of interest that is higher than the rate allowed by law is referred to as usury. There are typically severe penalties for usury in most states, such as penalties for fines, or even the loss of interest and principal. The legally-required rate of interest is also referred to as the highest rate that lenders are able to charge for any legal claim that can be enforced in a court of law.

In the United States, individual states have the responsibility of establishing their own interest rates laws. Although this type of financial activity could be covered by the Constitution’s commerce clause, Congress has not traditionally been concerned with the issue of usury. The government regards that the collecting of interest through violent means a federal offense.

What is the legal rate of Interest is Applied different jurisdictions

Every state can set a legal interest rate by enacting the laws of their respective states. For example, New York set its interest rates quaterly. Delaware’s rate of interest is 5%1 above the Federal Reserve rate, which means it is subject to fluctuation.

Additionally to the above limits, each state generally sets separate general usury limits which could be higher. New York’s limit is 16%2 in civil usury and 25%3 for criminal usury. Banks and other lenders of financing who conduct business in the state of New York could be subject to that state’s legal rate of interest.

There are some exceptions and conditions that permit lenders charge rates that are higher than of a jurisdiction’s legal amount of interest. Customers can choose to waive this protection when they apply for credit. Some lenders and financiers might require an agreement be signed by customers in order to obtain any loan.

The language that grants the company the authority to offer higher interest rates might be included in the conditions of service. Agreeing to receive financing at the interest rate assigned by the lender may override any protections a legal rate of interest provides, regardless of regardless of whether the customer later declares that they fully understand her rights.

Special Considerations to the Legal Rate of Interest

The lending institution could be able to bypass a legal rate of interest through similar techniques used to circumvent usury laws. For instance credit card companies are allowed to charge interest rates in accordance with the state in which the company is formed rather than the states where their customers reside. The lender could choose to be incorporated in a state such as Delaware that has less restrictive usury laws in comparison to the other states.

Credit card companies usually have the option of charging interest rates that are permitted by the state where the business was founded instead of adhering to the usury laws that apply to the states in which borrowers reside. Nationally chartered banks also have the option to use the highest interest permissible by the state in which the institution was established. Through incorporation into states like Delaware or South Dakota, lenders have traditionally enjoyed greater flexibility allowed in those states’ more relaxed laws on usury.