Legal Definitions - illegal interest

Illegal interest refers to any interest rate charged on a loan that exceeds the maximum rate permitted by law. These legal limits, often established through what are known as usury laws, are designed to protect borrowers from predatory lending practices by setting a ceiling on the cost of borrowing money. When a lender charges an interest rate above this legally defined threshold, the excess portion is considered illegal interest.

Here are some examples to illustrate this concept:

• Personal Loan with Excessive Rates: Imagine a person needs to borrow $2,000 quickly to cover an emergency. They approach a private lender who offers the loan but demands an interest rate of 10% *per month*. If the state where this transaction occurs has a usury law capping the annual interest rate for personal loans at 30%, the lender's offer is problematic. A 10% monthly rate translates to an effective annual rate of 120% (10% x 12 months), which is significantly higher than the legal 30% limit.

  Illustration: In this scenario, the 120% effective annual interest rate far exceeds the state's legal maximum of 30%. The interest charged above the 30% annual limit would be considered illegal interest, and the borrower might have legal recourse to challenge it.

• Short-Term Business Advance: A small business owner takes out a short-term cash advance of $1,500 to cover an unexpected inventory shortage, agreeing to repay $1,750 in three weeks. While the dollar amount of the fee ($250) might seem manageable, when annualized, it can represent an extremely high interest rate. A $250 fee on a $1,500 loan for three weeks equates to an approximate Annual Percentage Rate (APR) of about 289% ($250 / $1,500 * (52 weeks / 3 weeks)). If the state's usury laws cap the APR for such commercial advances at 50%, then the interest charged is unlawful.

  Illustration: The effective annual interest rate of 289% on this short-term business advance dramatically surpasses the state's 50% usury cap. The portion of the interest that exceeds this legal limit would be classified as illegal interest.

• Real Estate Development Loan: A developer secures a private loan of $500,000 to finance a new construction project, agreeing to an interest rate of 35% per year. The state's general usury law, which applies to commercial loans of this nature, sets a maximum allowable interest rate of 18% per year, unless specific, higher-rate exceptions are met (which are not applicable in this case).

  Illustration: The 35% annual interest rate charged on this development loan is nearly double the legal maximum of 18% established by the state's usury laws. The interest charged above the 18% threshold constitutes illegal interest, potentially allowing the developer to challenge the terms of the loan.