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Monetary Policy Interest Rates

The Legal Rate of Interest Defined

By Adam Hayes

Updated January 14, 2021

Reviewed by Eric Estevez

What Is the Legal Rate of Interest?

The legal rate of interest is the highest rate of interest that could legally be charged on any kind of debt and to which a lender is required to adhere. The legal rate of interest applies to all kinds of debt, however certain types of debt may be subject to a higher legal rate than another–for instance, the legal limit for payday lenders may be more than the limit set by law for student loan. The limit is established to stop lenders from charging customers excessive interest rates.

Important Takeaways

It is legal to charge the most high rate of interest that could be legally charged for any kind of debt.

Certain kinds of debts may carry a higher legal rate than another.

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

An interest rate that exceeds the rate allowed by law is considered to be usuary for which there are stiff penalties in most states.

Each state sets a legal rate of interest and usuary rates in their own laws.

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Understanding the legal rate of interest

An interest rate that exceeds the legal rate of interest is classified as usury. There are usually stiff penalties for usury in the majority of states, such as fines , or even the forfeiture of interest and principal. The legal rate of interest is also referred to as the most expensive rate lenders can charge for legal claims that can be enforced in the courts of law.

The United States, individual states are responsible for setting their own interest rates laws. While this kind of financial activity could be a violation of the Constitution’s commerce clause, Congress has not traditionally focused on usury. The government has considered collecting interest with violent means to be an offense of the federal government.

How the Legal Rate of Interest is Applied Different Jurisdictions

Every state can set a legal rate of interest through their respective 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 means it is subject to fluctuation.

Alongside these limits, each state typically sets its own usury guidelines that could be higher. New York’s limit is 16%2 for civil usury, and 25%3 for criminal usury. Banks and other providers of financing who conduct business in the state of New York could be subject to that jurisdiction’s legally-enforceable rate of interest.

There are some exceptions and conditions that permit lenders charge rates higher than of the lawful rates of interest. Customers can choose to waive this protection when they apply for financing. A lot of lenders and financiers require such an agreement to be signed by their customers to receive any financing.

The language that grants the business the ability to charge higher interest rates may be included in the terms of service. Agreeing to receive financing at the interest rate that is set by the lender can override the protections that a legal rate of interest offers, regardless of whether the client later attests to fully understanding her rights.

Special Considerations to the Legal Rate of Interest

The lending institution could be able to get around a legal rate of interest through similar techniques used to circumvent lawful interest rates. For instance credit card companies are allowed to charge interest rates according to the state in which the company is formed instead of the states in which their customers reside. The lender might choose to incorporate in a state like Delaware which has more relaxed usage laws than other states.

Credit card companies typically can charge interest rates that are permitted by the state where the business was established rather than follow the laws on usury that are to the states in which borrowers reside. Nationally chartered banks also have the option to use the highest interest rate allowed by the state where the institution was established. When they incorporate in states like Delaware or South Dakota, lenders have historically benefited from greater leeway permitted by the states’ usury laws that are more flexible.