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Monetary Policy Interest Rates

The Legal Rate of Interest Defined

By Adam Hayes

Updated January 14, 2021

Read by Eric Estevez

What is the Legal Rate of Interest?

The legal rate of interest is the highest amount of interest which could be legally charged for any kind of debt and to which a lender must conform. This rate is applicable to all kinds of debt, however certain kinds of debt could be subject to a higher legal rate than another–for instance, the legal limit for payday lenders might be more than the limit set by law for a student loan. The limit is established to stop lenders from charging customers excessive interest rates.

The most important takeaways

The legal rate of interest is the highest rate of interest that could legally be charged on any kind of debt.

Certain types of debt may be subject to a higher rate of legal than other.

The limits are in place to ensure that lenders do not charge the borrowers high interest rates.

A rate of interest that is higher than the legal rate of interest is classified as usuary, with severe penalties in the majority of states.

Each state sets a legal rate of interest as well as usuary rates by enacting their own laws.

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Understanding the legal rate of interest

An interest rate that exceeds the legal rate of interest is known as usury. There are typically severe penalties for usury across all states, including fines , or even the forfeiture of the principal amount and/or interest. The rate of interest that is legal is also referred to as the highest rate that lenders are able to charge for any legal matter which can be enforced in a court of law.

The United States, individual states have the responsibility of establishing their own interest rate laws. Although this kind of financial transaction could be covered by the Constitution’s commerce clause, Congress has not traditionally concentrated on the issue of usury. The government considers that the collecting of interest with violent means to be as a federal crime.

What is the legal rate of Interest is applied in different jurisdictions

Every state can set a legal interest rate through their laws. For example, New York set its interest rates quaterly. The legal rate of interest for Delaware is 5%1 higher than that of the Federal Reserve rate, which makes it subject to fluctuations.

Additionally to the above limitations, each state usually sets separate general usury limits that may be more or less. New York’s limit is 16%2 for civil usury and 25%3 for criminal usury. Banks and other providers of financing that do business in a particular state may be subject to that state’s legally-enforceable rate of interest.

There are certain exceptions and conditions that permit lenders charge rates in excess of a jurisdiction’s legal rates of interest. Customers are able to choose to waive this protection when they apply for financing. Some lenders and financiers might require an agreement be signed by the customer for any financing.

The language that grants the company the authority to increase interest rates could be included in the terms of service. If you agree to receive loans at the rate set by the lender can override the protections that an official rate of interest offers, regardless of whether the customer later attests to fully understanding 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 example, credit card providers are allowed to charge interest rates according to 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 like Delaware that offers more relaxed usage laws as compared to other states.

Credit card companies usually have the option of charging interest rates that are allowed by the state in which the company was incorporated instead of adhering to usury laws that apply in the states where borrowers reside. Nationally chartered banks can also use the highest interest allowed by the state where the institution was established. When they incorporate in states like Delaware and South Dakota, lenders have historically enjoyed more flexibility granted by those states’ relaxed usury laws.