Usury Laws

What It Means

Usury laws in the United States limit the fees, called interest, that lenders can charge those who borrow money. Usury laws vary from state to state, and they consist of a maximum rate (a percentage of the total loan amount) that lenders can charge.

Though usury today is defined as charging more interest than the law allows, many civilizations in history defined usury as charging any interest at all and either looked down on the practice, made it illegal, or limited its use. The distaste for interest generally stemmed from a belief that one should not be able to collect money from someone without doing anything to earn it, and religious societies in particular tended to believe that interest was incompatible with morality. Gradually interest came to be considered a necessary part of ordinary business, and lenders were seen as providing a useful and valuable service. Prejudices against the practice are minimal in the modern world, but many people still worry about the ability of large lenders such as banks and credit card companies to take advantage of consumers.

Today’s usury laws, therefore, are meant to prevent abuses by lenders. If a business that charges interest violates a state’s laws, it may be fined, prevented from collecting any interest from the consumer, or both.

When Did It Begin

Whether or not the charging of interest is legitimate is a question that dates back to the dawn of Western civilization. The Greek philosopher Aristotle (384–322 bc ) offered the definitive argument against the collection of interest in the ancient world. In his work Politics he wrote that money was intended to be exchanged for other goods, not used to create more money; interest was, in his view, the most unnatural of all ways of acquiring wealth. The legal codes in ancient Rome did not strictly prohibit interest, though they did strictly limit the forms of interest that could be charged, and a maximum interest rate of 12 percent was established in 88 bc . This cap on interest rates remained in place until 533 ad , when the Emperor Justinian established a variety of different maximum interest rates depending on the form of the loan.

In the Christian-dominated world of medieval Europe, interest was considered usury and was outlawed, though it was legal to profit from a loan as long as the lender shared the borrower’s risk (that is, stood to lose the money if the borrower’s venture failed). By the 1500s, however, increasing business activity led to an increased demand for borrowed money, and some theologians began arguing for the loosening of the restrictions on interest. Gradually, the attitudes toward usury of most Christian thinkers and secular lawmakers shifted, so that the main criteria became not simply the existence of interest, but the intentions of the lender. Usury laws in the sixteenth and seventeenth century outlawed only excessive amounts of interest, which were deemed immoral.

U.S. usury laws followed this approach. Basing their usury laws on existing English laws, the early colonies and states outlawed excessive levels of interest as violations of moral standards.

More Detailed Information

Usury remains a matter defined mainly by the states rather than the federal government. The federal government requires, as part of the Truth in Lending Act (1968), that lenders disclose the interest rates that they charge borrowers prior to making a loan, but it does not set any limits on rates. Different states set different rates, and these rates have been subject to substantial revision over the course of history, often as a result of evolving local economic conditions.

Most states also tend to establish different rates for different kinds of loans. Loans for the purchase of consumer products (such as cars or appliances), for instance, are generally allowed to carry higher interest rates than mortgage loans (loans for the purchase of homes). Some states do not regulate the interest rates that lenders can charge large companies, since companies have the leverage necessary to negotiate with lenders.

Usury laws apply to any business that makes loans. Examples include banks, mortgage companies, rent-to-own stores, and credit card companies. Individuals who make informal loans to one another are also subject to usury laws. If you loan a friend $1,000 and try to charge him an interest rate of 75 percent, you would likely be in violation of your state’s usury laws. The practice of setting illegally high interest rates and using the threat of force to collect payments is called loan sharking. Loan sharks often work for organized crime syndicates (also known as the mob), providing loans to people who cannot obtain them from legal businesses. When loan sharks get caught, they are often prosecuted for violation of usury laws, fined, and imprisoned.

Legal businesses in violation of usury laws are generally fined and/or prevented from collecting the illegal interest that they are seeking to collect. Sometimes courts alter lending agreements found to be usurious, making borrowers liable only for the principal (the original amount of the loan) plus payments that equal a legal interest rate.

Economists often dismiss the effectiveness of usury laws, pointing out that most such laws have origins in religious rather than economic theories and that they prevent the efficient functioning of credit markets (the system bringing together lenders and borrowers). In economic theory, markets driven by self-interested sellers (lenders, in this case) and self-interested buyers (borrowers) are generally considered more effective regulators of economic affairs than the government. Even extremely high interest rates are sometimes justified by economists as a fair compensation for the high level of risk that some borrowers represent.

Consumer advocates, on the other hand, claim that usury laws are needed to protect individual borrowers, who have little or no leverage over lenders (often large corporations such as international banks). Other proponents of strong usury laws claim that high rates of interest are unethical because those people who must borrow money at extremely high rates often do so out of necessity, because of financial hardships that make them unqualified for more attractive loans.

In general, usury laws in the United States rarely interfere with the interest rates businesses want to set. This is because individual states typically make allowances for companies and do not aggressively seek to control credit markets. Consumers themselves are largely responsible for guarding against the negative effects of high interest rates.

Recent Trends

In the late twentieth and early twenty-first century, credit card companies charged rates of interest that many people considered usurious. It was possible, at this time, for someone who had fallen behind on credit card payments to be charged interest of 30 percent or more per year.

Credit card companies’ ability to charge such high rates was connected to the absence of any national standards for usury. Fewer than half of all U.S. states limited the interest rates that credit card companies could charge, so credit card companies were able to seek out those states lacking usury laws and establish their headquarters there. Even if a credit card holder was based in a state with strict usury laws (Arkansas, for example), those laws did not apply if that person owed money to a credit card company based in a state that did not cap interest rates. Only the law in the lender’s home state applied.

The credit card division of the New York-based Citibank, for example, moved its headquarters to South Dakota in 1981 in order to take advantage of that state’s lax usury laws. Likewise, the following year, four other credit card companies moved their operations away from traditional financial centers and into Delaware, where similarly liberal restrictions applied. In response, other states began raising or eliminating their interest-rate caps, hoping to make themselves more attractive to credit card companies.