What is Usury?
Usury laws are laws that regulate interest rates, and by extension, fees and charges imposed on borrowers in place of interest. Until relatively recently, usury laws were intended to curtail what were considered to be excessive and unconscionable interest rates and fees imposed on borrowers by private lenders like banks and credit card companies. However, as will be explained below, usury laws vary considerably from state to state and they are not as unilaterally consumer good law as one would think.
The term usury is derived from the Latin term usura, which meant an extra payment required for a loan. Forms of usury have existed for millennia, starting with the Code of Hammurabi (a Babylonian law code from 1755 BC) and appearing in the Old Testament of the Christian Bible. Historically, usury refers to the practice of charging an amount of interest on a loan that is more than what is allowed by law, or an amount of interest that is unreasonable, excessive, or prohibitive. The notion of usury as an illegal practice was handed down through the years, with the "usury loan shark" of today being a sophisticated successor to the cobblers and bakers who once demanded more than was allowed by law or otherwise reasonable.
One of the principal reasons usury has historically been frowned upon by governments is that predatory lending practices were often employed more frequently against poor people than wealthy people. Today, there is considerable diversity among the states when it comes to usury laws. Some states, like Nevada , have few restrictions on either payday loans or loan fees. Other states are more restrictive. Alabama, for example, prohibits any and all payday loans. Florida caps payday loan amounts at $500, while Pawnshops in Alabama can charge up to 25% interest per month for loans of any amount.
Interestingly, there has long been a tension between the common sense notion of predatory lending and its application by the courts. For example, the U.S. Supreme Court decided in Global-Tech Appliances Inc. v. SEB SA, 563 U.S. 754 (2011), that willful ignorance by corporate decision-makers who were uninvested in a project did not equate to ‘knowledge’ under the provisions of the Sherman Act. To the extent that the U.S. Supreme Court applies a subjective standard to the concept of knowledge, as laid out in Global-Tech Appliances, and then the federal Courts of Appeal apply a more objective standard to the concept of knowledge, as they did in Castrol, Inc., v. Pennzoil Co., 987 F.2d 939 (3d Cir. 1993), courts may be wary about recognizing or establishing a predatory lending doctrine for purposes of civil liability.
One of the central principles of usury laws is protection for the borrowers. In general, state usury laws permit borrowers to assert claims against lenders who charge unlawful interest rates or fees. A borrower is eligible to recover monetary damages for "actual pecuniary loss sustained" as a result of the usurious interest charge or fee. In other words, a borrower may sue a lender for the amount that he or she paid the lender, above and beyond the lawful amount, and recover the difference.
A Primer on Arizona Usury Laws
In Arizona, usury laws are primarily governed by A.R.S. § 44-1201 through 44-1233. There is no cap on the interest rate for loans between individuals for amounts of $250,000 or more. Residential mortgage loans are specifically excluded from the definition on usury under A.R.S. § 44-1201. That exception does not include home equity lines of credit. A.R.S. § 44-1202(D)(2).
Like other states with a usury statute, the Arizona statute does not create a cause of action in tort for damages incurred by the loan at a usurious rate. Rather, it is intended to protect the financial and economic interests of the public. In 1989, the Arizona Supreme Court stated, "The purpose of the usury statutes is to protect the ability of citizens, and particularly those with limited bargaining powers, to borrow money." Rimes v. Maricopa County, 733 P.2d 1138, 1140. Usury laws are intended to protect unsophisticated borrowers from malicious lenders; the goal is to prevent those with less bargaining power from being taken advantage of.
In Arizona, a default interest rate based on the failure to pay under a usurious contract is also subject to the usury statute. A.R.S. § 44-1202(E). The Arizona Supreme Court held in Harris v. Ariz. Laborers, Teamsters and Cement Mason Local No. 395 Pension Trust Fund, 201 Ariz. 261 (2002) that the usury statute protects all borrowers regardless of their level of business sophistication.
One unique aspect to Arizona’s usury language is that when the lender and borrower do not reside in the state, the lender cannot charge a higher rate of interest than that permitted in the state where the transaction was entered into. A.R.S. § 44-1202(C).
Exceptions and Exemptions to Usury Laws
Exceptions and exemptions to Arizona’s usury laws include several transaction types and financial entities. While many types of loans are subject to the usury laws, the following exceptions and exemptions are most often encountered.
The first key exception is for tax-advantaged loans. Tax-exempt organizations and government agencies may make loans without being subject to the usury rates. The second exception is a loan secured by real property made to an industrial development authority. While an industrial development authority (IDA) is not exempt from the usury laws entirely, it may enter into loan agreements with a "developer" if the loans are secured by real property only. The developer must be the owner of the property encumbered by the loan, and the IDA can only make the loan if it passes a resolution stating that the loan is justified by public health, safety, morals or welfare.
The third exception is an exemption for loans from a bank that are related to a "sale or lease of improvements on real property." Loans categorized as "seller-financed" sales are a fourth exception noted in the usury laws. Seller-financed loans are deemed exempt from the usury rate requirements if:
1. The lease or sale transaction does not exceed 36 months; and
2. The property being sold or leased is not the land on which the loan is secured.
A fifth and final noted exemption is related to loans to financial institutions. Under this exemption, any loan to a financial institution is allowed to be made at a rate of interest higher than 10 percent. Of note, this exception states that these loans are not subject to the money lending statutes. However, it is not explicitly stated whether this exemption is intended to apply to usury laws as well.
Potential Consequences of Breaking Usury Laws in Arizona
Violating the usury laws in Arizona can have both legal and financial ramifications. The legal consequences depend on the nature of the loan or credit instrument and the amount of interest involved. For instance, any loan agreement that requires a borrower to pay an interest rate above the usury threshold will be declared void and unenforceable. A lender would not be able to bring an action to recover interest charges over and above the usury rate. Besides a void loan agreement, usury charges may also affect the credit record of the borrower. Legal penalties for loan contracts involving usury charges may extend well past the original loan contract itself. A lender may be forced to return loan payments with interest at a rate equal to the usury threshold.
In enforcement of the usury penalties, the Court may award some or all of the following remedies to the borrower:
If it appears to the Court that a lender has in its possession the note and has retained the usurious interest , the lender shall hold the same and on motion of any interested party, or on its own motion, may order the lender to apply the usurious interest against the principal of the loan. If, upon motion, a borrower can show excessive usurious interest to the amount of 10% or more of the original loan, the Court may re-open the transaction between the parties and determine the real amount of interest to be paid. If the Court finds excessive usurious interest, it may also award a greater sum to the borrower as damages.
Actions for excessive usurious interest must be brought within one year after the usurious interest has been paid, except that such actions for excessive usurious interest against a lender residing out of the state must be brought within one year after payment to the lender. No action may be brought for excessive usurious interest unless payment of the amount due has been made or tendered to the lender.
How to Avoid Uusury
The best way to protect yourself is to be on alert of how you can be affected by usury. If you’re not sure if a loan contains an illegal interest rate, ask. Arizona law has not been actively enforcing these laws for years and as a result it is becoming more common for lenders to charge above the legal rate without concern. But it is illegal.
If you are going to obtain a secured loan, such as a mortgage or a car loan, make sure you know what interest rate is legal. The key to be protected is making sure you ask the lender to explain the entire package including interest, fees, and the total amount of interest you will pay over the term of the loan. Lenders are required to provide you a Truth In Lending statement which shows you the numerical breakdown so you can see the true cost of the loan.
If you find that the lender has quoted you an illegal interest rate, tell them. If they continue to offer you the loan you may have to seek legal assistance.
Remember an interest contract will not always be illegal. For example, should a lender legally charge more interest as a result of various business models such as interest-only loans? If a lender offers you an interest amortized differently than the periodic payments, ask why. It is legal to charge more interest, but the lender must fully disclose your entire financial obligation in a clear way so you fully understand what you are signing.
Recent Developments and Changes to the Law
In recent years, the Arizona legislature has made notable changes to usury laws that impact commercial transactions. The amendments to the statutes have signaled ongoing modernization of the law to adapt to contemporary commercial financing contexts and relationships. For example, in 2017, legislation was passed, expanding the applicability of certain exemptions to the statute if the parties are authorized to engage in the activity under Title 6.
The changes in 2017 also included a focus on the treatment of a single creditor having multiple loans to a single borrower. Under the pre-amendment law, if a single lender entered into multiple loan agreements with the same borrower, with the same maturity date and where the lender made all the loans under state law, almost any other loan agreement between that lender and borrower of the same general type would be usurious if the aggregate amount of principal and accrued interest exceeded the limit on the earlier loan agreement. The rationale behind the law was that it was implemented to prevent creditors from manipulating loan agreements with the intent of getting around the limits of the usury statutes. However, the law had a disparate impact on large commercial lending transactions that involve parties funding through multiple entities. For example, if a venture capital fund made a number of loans to a single entity, engaging many different lenders but the same borrower, the aggregate of each entity’s loan was used to determine if the loans were usurious .
Under this rationale, smaller loans could be assessed higher interest, as long as the higher loans were "fresh" loans without other loans existing, or the lender could engage in a denominated "dummy" loan to the borrower with a maturity date of 100 years, but with no further obligation, exposing the borrower to indefeasibly high interest rates on fresh loans in short order. The 2017 amendments worked toward easing the tension imposed by the usury laws by allowing a commercial borrower to refinance the earlier loans without the later loans becoming usurious. The 2017 amendments also make it clear that a "debt cancellation contract" is not the same as a loan, but nonetheless may be subject to usury laws.
While these changes were helpful, particularly as they apply to the commercial loan context, uncertainty remains in the legal community about what constitutes a "business loan." For example, the usual litigation around what constitutes "credit extended in the regular course of the lender’s business" under the statute remains an open question, in several contexts, under the statute. In the apartment lending context, it is unclear whether loans are considered "business loans" for purposes of the loan agreements. Further, it remains to be seen how the 2017 changes will affect transactions, where these issues went unresolved after the amendments.