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Monetary Policy Interest Rates

Legal Rate of Interest Definition

By Adam Hayes

Updated January 14 2021

Review by Eric Estevez

What is the legal rate of Interest?

1 year agoLegal rates of interest are the highest rates of interest that can legally be charged on any type of debt and to which lenders must adhere. This rate is applicable to all kinds of debt, however certain types of debt may be subject to a higher legal rate than others. For instance, 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 the borrowers with high interest rates.

The most important takeaways

The legal rate of interest is the most high percentage of interest that could be legally charged for any type of debt.

Certain kinds of debts may have a higher legal rate than others.

The limits were set to stop lenders from charging the borrowers high interest rates.

A rate of interest that exceeds the legal rate of interest is referred to as usuary, for which there are stiff penalties in most states.

Each state determines a legal rate of interest and usuary rates through their respective laws.

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Understanding the legal rate of interest

An interest rate that is greater than the rate allowed by law is classified as usury. There are usually severe penalties for usury across all states, like penalties for fines, or even the loss of principal and/or interest. The legally-required rate of interest could also be categorized as the most expensive rate lenders can charge for legal claims which can be enforced in a court of law.

The United States, individual states are accountable for establishing their own interest rates laws. Although this kind of financial activity could fall under the Commerce Clause of the Constitution, Congress has not traditionally concentrated on the issue of usury. The government considers the collection of interest payments by means of violence to be an offense of the federal government.

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

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

Alongside these limits, each state typically has its own general usury limit that could be more or less. New York’s limits are 16%2 for civil usury and 25%3 in the case of criminal usury. Banks and other providers of financing that do business in a particular state may be subject to the state’s legally-enforceable rate of interest.

There are certain exceptions and conditions that permit lenders charge rates higher than of a jurisdiction’s legal amount of interest. Customers may choose to opt out of this protection when they apply for financing. Many lenders and financiers may require an agreement be signed by the customer in order to obtain any loan.

The clauses that grant the company the right to charge higher interest rates may be included in the terms of service. Accepting financing at the interest rate assigned by the lender could outweigh the security that the lawful rate of interest offer regardless of whether the customer later affirms that she fully understands her rights.

Special Considerations in the Legal Rate of Interest

Some lenders may be able bypass a legal rate of interest by using similar strategies used to avoid usury laws. For instance credit card companies are permitted to charge interest rates based on the state where the business is registered rather than the states where their customers live. The lender could choose to incorporate in a state such as Delaware which has more relaxed rates of usury than other states.

Credit card companies generally have the option of charging interest rates which are allowed by the state in which the business was established rather than follow the rules on usury in the states where the borrowers reside. Nationally chartered banks similarly can apply the highest interested allowed by the state where the company was founded. Through incorporation in states such as Delaware as well as South Dakota, lenders have traditionally enjoyed greater flexibility allowed in those states’ usury laws that are more flexible.


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Related Terms

Usury Laws: Definition, Purpose, Regulation, and Enforcement

Usury laws determine how much interest can be charged on a loan. These regulations exist to protect the borrowers.


Usury Rate

The term”usury” refers to an amount of interest that is deemed to be high compared to prevailing market interest rates.


What Is Usury? Definition, how it functions, Legality, and Example

Usury is the act of lending money with an interest rate which is thought to be unreasonably high or that is higher than the rates permitted by law.


What is a Payday Loan? How It Works, How to obtain One and legality

A payday loan is a type of short-term borrowing where a lender will extend high-interest credit dependent on your income.


What is Articles of Incorporation? What’s Included

Articles of incorporation is a set of formal documents filed with a government body to document legally the formation of a corporation.


Delaware Corporation: Definition, Role of Usury Laws and Benefits

A Delaware corporation has the advantage of being registered in the state of Delaware however it can also operate in any state.


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