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Monetary Interest Rates for Policy

Lawful Rate of Incentives Definition

By Adam Hayes

Updated January 14, 2021

Review by Eric Estevez

What Is the Legal Rate of Interest?

Legal rates of interest are the highest amount of interest which could be legally charged on any kind of debt and to which a lender must conform. Legally, the rate is applicable to all types 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 a student loan. The limit is established to stop lenders from charging borrowers high interest rates.

Important Takeaways

Legally, the rate for interest can be considered to be the highest rate of interest that can be legally charged on any kind of debt.

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

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

A rate of interest that exceeds the maximum legal rate of interest is classified as usuary, with severe penalties in most states.

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

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Understanding the legal rate of interest

An interest rate that is greater than the maximum legal rate of interest is referred to as usury. There are usually severe penalties for usury in most states, like fines , or even the forfeiture of the principal amount and/or interest. The legally-required rate of interest could also be categorized as the highest rate that lenders are able to charge for any legal claim which can be enforced in the courts of law.

The United States, individual states have the responsibility of establishing their own interest rates laws. While this kind of financial transaction could fall under the Commerce Clause of the Constitution, Congress has not traditionally concentrated on usury. The government regards that the collecting of interest payments through violent means an offense of the federal government.

How the Legal Rate of Interest is applied in Different Jurisdictions

Each state may set a legal interest rate through their laws. For example, New York set its interest rates quaterly. Delaware’s rate of interest is 5%1 higher than the Federal Reserve rate, which allows it to be subject to changes.

Additionally to the above limits, each state typically sets its own usury guidelines that may be higher. New York’s limit is 16%2 in civil usury, and 25%3 for criminal usury. Banks and other lenders of financing that do business in the state of New York could be subject to that jurisdiction’s lawful rate of return.

There are some exceptions and circumstances that may let lenders charge rates higher than of the lawful rate of interest. Customers can choose to waive this protection when they apply for financing. A lot of lenders and financiers require an agreement be signed by the customer to receive any financing.

The clauses that grant the business the ability to offer higher interest rates might be in the terms of service. Accepting credit at the rate set by the lender can override the protections that an official 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 avoid a legally-enforceable rate of interest using similar methods used to circumvent usury laws. For instance credit card companies can 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 usage laws as compared to other states.

Credit card companies generally have the option of charging interest rates that are allowed by the state where the business was established instead of adhering to rules on usury in the states where borrowers reside. Nationally chartered banks similarly can apply the highest interested permitted by the state in which the institution was established. Through incorporation into states like Delaware as well as South Dakota, lenders have traditionally enjoyed greater flexibility permitted by the states’ more relaxed laws on usury.