Private money lending and CA usury law

24 Replies

As a rehabber, I'm willing to borrow money at more than the usury-limited rate of 10% (I live in California). I have seen posts in the past indicating that private money can be loaned at higher interest rates if the borrower is a company (we have an LLC). However, I have done a bit of searching online and I have been unable to find applicable California law that would corroborate this, other than if the company already has $2million in assets and has a previous working relationship with the lender.

Does anyone know if it is true in California that a loan can have more than 10% interest as long as it is a company (LLC) borrowing the money, regardless of the company's asset value or previous relationship with the lender? If so, can you please point me to the corresponding law explaining it?

Thanks for any assistance!

Thanks for the reply, Mitch. This is great!

I looked over all the laws, and I did find an exclusion that might be the exemption I have seen others refer to. It only applies if a person makes a commercial loan no more than once in a 12 month period, though. This would rule out using an individual investor's funds on more than one property per year, which seems limiting.

Other than that one, I didn't see anything that would be a general exemption from the usury law that I could use. We're not real estate brokers, or pawn shops, or any of the other things that would automatically exempt us. I guess there was one other thing, which was the "shared appreciation loan", but that would mean sharing profit, which I'd rather not have to do in every case.

I guess maybe we can just limit the interest rate to 10% and not worry about the usury law, but then I'm not sure if that would be competitive with other Flippers.

I feel like I'm missing something. Or maybe everyone else is just ignoring the law because really, the Flipper is the borrower and as such, they're not going to report the person they're getting money from.

Originally posted by Mike G.:
I feel like I'm missing something. Or maybe everyone else is just ignoring the law because really, the Flipper is the borrower and as such, they're not going to report the person they're getting money from.
From the flipper's side, you are right. If you are willing to pay more than 10%, you are risking nothing, only the lender and why would you complain unless you never wanted them to lend to you again.
That said, it is the responsibility of the lender and the risk of the lender to charge more for loans here in CA unless it is made using a DRE license.

I often pay higher than 10%, but often it is from a private investor whom I have borrowed from in the past and have a working relationship with.

Okay, so it seems like I kind of came to the right conclusion/understanding.

Thanks for the response, Will!

This is not legal advice. I am not a lawyer but this is what my lawyer says to do.
Any state's laws can typically be "imported" on a per deal basis. Contracts have a clause that says "This contract shall be under the laws of X state"

Find an out of state lender and draw up the note and mortgage under his state laws if they have commercial exemptions like most do.

All that said, you really just need to find a lender to trust you. Usury laws are virtually never enforced except on a complaint from a borrower. You are the borrower. So if the lender understands that under no circumstances would you complain or cooperate with an investigation, he is really under no risk violating the law, as a practical sense.
You can also structure deals as low interest with a percentage of profits kicker with a cap.

Hi, Eric.

Thanks for the ideas. I was actually thinking of one of those (percentage of profits with a cap) after reading about the shared appreciation exception in the legal code. Good ideas, and I think you and Will are right - it would mostly boil down to trust between the lender and us anyway.

One of the easiest ways to give yoru lender a "warm and fuzzy" is to include in your note the following: Borrower understands that this note is in excess of the state usury laws and hereby agrees to perform to the specific notes of this agreement. Furthermore, this loan is not primarily for personal, family or household purposes, but for business purposes only.

Disclaimer: This is NOT legal advice and the wording was not written by an attorney. It is for infomational purposes only.

Another excellent idea - thanks, Will!

One final thought: Usury laws are exempt in CA and many other states if a licensed broker is involved in the transaction.

Well, Happy Holidays! IMO, the best way would be to build in lending opportunities into your LLC for a private lender to become a member and lend the money through the capital account. If properly drawn, there is no doubt that it is a commercial loan and the collateral is held by the LLC and assigned to that lender.

Drafting any clause that is contrary to state law may well be worthless as many rights, especially consumer rights or protections provided by law can not be relinguished by the consumer or individual even if by agreement. And, the fact that a borrower agrees to pay an amount over the usury rate is a violation of the lender, not the borrower.
An example of this is when a corporation, say a small cell phone company, incorporates penalties in their contracts that require additional fees for collections of a late payment. Usually under state law, late fees will have some cap and making additional charges in connection with such a payment will be viewed as part of the late fee. The consumer can not waive such rights.
Even by paying the fees.

I have also seen where usuary laws were violated that the lender ended up owing a fine to the state, but never had to remit overages to the borrower, especially when the loan had been paid off and the borrower was long gone.

Will is absolutely right that in a private lending arrangement, where no compliance audit is performed by the state that if a borrower never complains, it may go undetected. But borrowers die, they become incapacitated and others may end up standing in their place to wind up business, so from the lending side, it would not be wise, IMO, to simply have a usurus note.

State law should be investigated with peripheral laws as well, references to usury within any state may include tax law, commerce and other secured lending requirements where they may become applicable. So I suggest you see your attorney.

Any lender that does business in another state must abide by that state law, where the collateral resides, the home office is irrelevant. Think about it, Bank of America may have its national or international headquarters in one state, but the loans they make elsewhere are written to conform to the state law where the loan is made, and with real estate loans, that means where the collateral is located.

As to a shared appreciation arrangement, I'd suggest going back to the LLC suggested. If you have a formal partnership, that may also work out for you. To do any shared appreciation agreement in connection with a loan or subject to a loan being made, you will still be in viloation as the Truth In Lending Act requires all loan expenses or other charges made in connection with the loan be computed for the APR, and it will be generally be the APR that any usury rate will be applied to. Ahh, but this is a private lender and the TIL may not apply, ahhh, but, if the private lender is in the business of lending money, it may very well apply.

Without a doubt, IMO, the best way is for the lender to be in the LLC as a very limited member, make a contribution to capital and receive the applicable profits, a small rate of interest and his principal back. Good luck, Bill

The suggestion to have a private money lender be a partner in the LLC does not seem feasible to me, unless you create a different LLC for each property. Maybe creating a new LLC each time is a reasonable solution in another state, but it doesn't seem realistic here in California. Forgetting the potential legal fees, just creating an LLC costs $800 here.

And then there is the timing issue. I wonder if it would even be possible to arrange everything quickly enough. From the time the offer was accepted, you'd have to present the opportunity to the lender, get them on-board, file the LLC, get the EIN and documentation from the state, setup a bank account, deposit the funds, and then wire the money before close of escrow. As a flipper, we need to close fast, so our offers generally specify a closing time of two weeks. Maybe it would be possible to move this quickly somewhere else, but I don't think this is even remotely possible in California. If I'm wrong, I'd love to hear from others how this could work.

As for the shared appreciation mortgage, the law in California seems to be quite clear that any of the money that comes from the appreciation of the property is not counted as part of the interest rate. Mind you, I'm not a lawyer, but the Civil Code specifically refers to this in a number of places.

As for Will's comment about the broker involvement, he is correct in that if the broker arranges the deal, it will be exempt from the usury law. However, I have read that it can't just be a broker signing off on it, because that likely wouldn't hold up in court; it would have to be the broker actually negotiating the terms of the loan. So I've read, but I've obviously never tested this and can't point to a specific case.

Hi, yes, but I didn't mean form seperate LLCs or even one to lend out of, not at all. Your existing LLC that owns the property to be purchased (I assume) would admit a member, that member would provide the capital. If you're using an individual lender, that's an option, if it's an organized HML type, that might be harder.

A member can be admitted that has no voting rights, no management rights and can be limited in any respect that you desire. They can be passive and make contributions, receive any per cenatge of profit even up to a dollar limit, interest and principal. Sorry I didn't break that down.

I didn't read the CA statutes. I understand what you're saying about the two, but I was saying that if the shared amount was ONLY on the condition of making a loan, the finance department might look at it as a LOAN CONDITION, and not just a shared appreciation....I don't know if CA specifically is saying a loan with shared appreciation is not interest, it obviously is a benefit and consideration to make a loan, a cost of borrowing the money, almost the definition of interest.

Again, the individual lender would be admitted to the existing LLC, don't need to make new ones, and after the loan is paid off, take them out of the LLC, or they could remain dormant until the next loan. You could have a dozen such members. You would also need to make them feel warm and fuzzy, like providing them with a hold harless and indemnification covenant and limiting their liabilty....I'm talking about individuals here.

I have not read CA statutes again, but the SAFE Act really means that the Originator/broker will do the entire loan, and there is also the CFPA requirements too. As a seller, you may not dictate any terms or interest, that's on the way I believe. This being applicable to loans secured by residential property, so the commercial loan excuse may not fly. This is why making the individual lender a member makes it clearly a commercial loan to the company. The company owns the property and there is no deed of trust to the lender, the security agree,ment is in the Operating Agreement, among owners. That's really why I suggested you see an attorney, this is not a do it yourself thing to construct. By any means, Good Luck....

Bill, sorry I misunderstood your original suggestion, probably because the idea of having additional members in my company causes a knee-jerk fear reaction. :)

Okay, getting over that reaction, are you saying that the private money lender, as a member of the LLC, would make a capital contribution to the company rather than a loan? And then upon the sale of the property, that member takes a distribution of the entire amount of their initial contribution, plus whatever additional percentage we agreed to? I wonder what happens if we break even on the property or even lose money. In that case we still want to pay the lender their interest, but now if we do that I wonder if it would be considered a loan at that point and not a capital contribution.

A couple other concerns I'd have with that approach: because their money is now technically the company's money (as a result of it being a capital contribution), it is exposed in the event of a lawsuit; also, like you said, it is not secured against the property with a deed of trust. I would think this method would be less desirable to a potential lender. Or am I incorrect in this analysis? I hope I'm not coming across as a contrarian here, I'm just trying to consider the possibilities. And I really appreciate the ideas you and others are putting out.

As for the California laws regarding the shared appreciation... From my interpretation it says that any additional funds made beyond the fixed interest rate (which must still be less than the 10% usury limit) that are tied to the appreciation (or profit) from the sale of the property are not counted as additional interest for the purpose of the usury law. There are some restrictions to qualify for this exemption, such as the borrower not being an owner-occupant, and specifying on the Trust Deed that it is securing a shared appreciation loan.

Yes I think you have it! The security agreement can be filed to the capital acount of the member. The loan is made to the company...but I think you have the idea.

If I loan money to the company, it has no bearing on any profit of loss, I still am owed the P&I. Shared profits would come from the profit.

Your operating agreement covers the issues of participation, security for dbets owed to memberds, escrows, death, incapacitation, etc. In fact, as a lender/member, they could be better secured than with a standard deed of trust and having to foreclose in the event of default. The property can be assigned within the company to any capital account...bang...done! It's a UCC filing and you can file a lien on the property...that's why I suggested you contact your attorney. Good luck...and Merry Christmas!

@Mike G. In California, most of the private money loans I see are in violation of Usury laws.  The rule of 10% includes all points and other finance charges, so it is very easy to go over 10% if it is a 12-month or short-term loan.  Even an 8% loan with 2 points would violate Usury, if the loan was for a term less than 12 months.  

The best way to protect a higher interest rate or higher fee loan is to have a CA RE Broker negotiate and / or arrange your loan for a fee.  Another way is to do a loan at 10% interest with no points and do an agreement that also gives you a right to a portion of profit.  If there is not any profit, you still have a 10% mortgage against the property.  My rule... always be in 1st trust deed position, with an ALTA title policy to protect your position as a lender. Good luck :-)

I saw it suggested on this website that for example if usury is 10% you could write the loan for say 8% + 4pts for two years and not violate usury.  The 4 pts is spread over 2 years giving 10%/yr, not a usury violation.  If rehabber pays off in 12 months the roi is 14% but because the loan was written for 2 yrs it's 10%/yr from a usury perspective.  Most rehabbers pay off in less than one year thus giving an even higher roi.  This is not legal advice.

@David C. I do not believe that is sound advice.  I haven't looked into it in a while, but I recall the usury being based on the total amount paid within the year.  It didn't matter what was written, it mattered what was paid, unless the loan was a shared appreciation mortgage as mentioned by @David Oldenburg above.

@Mike G. @David C. I think David C. may be correct regarding the extended loan term, but that could create more problems. Under the newer ATM and QM rules, a loan over 12 months might not be exempt, because it is not a temporary or bridge loan. QM and ATR also give an exemption for a "business purpose" loan. I would be careful. I would always do private money loans under 12 months and then do an extension later if needed. The whole Usury thing is really stupid :-)... Of course, in my opinion! Here's why. It doesn't take into consideration the type of loan, LTV, or risk factors. I might loan at 10% to an inexperienced flipper, who puts down 50%. But, I would not do 10% if they put down 5%. Totally different risk levels, and there needs to be additional yield for that risk.

@Mike G. I don't know what the truth is.  Interesting idea though.  Being licensed myself I don't worry or even think about usury issues.

@David Oldenburg I don't know what ATM, QM or ATR are but I've been operating under notion that RESPA, TILA, SAFE, DF, CFPB don't apply if you can fit the loan in a "business purpose" box, carefully of course.

@David C. My apology, I got lost in acronym hell :-)... I meant ATR not ATM. ATR is Ability To Repay and QM is Qualified Mortgage.  You can google both of those.  Often referred to as QM ATR.  Rules that went into effect not too long ago. 

I don't like the "Business Purpose" exemption, as much as I like the "Bridge or Temp" loan under 12-month exemption for many rules.  I am also a CA RE Broker for almost 25 years, so I have that exemption.  The best thing is loan to other investors, for short-term, and use a RE Broker to arrange, if you are not already one!  There is also an amazing document company for private money that can do all your disclosures and greatly reduce your liability, but I can't recall their name. I will look it up and post it later.  

@David Oldenburg

A quick search on the internet seems to define a bridge loan as 12 months or less, not under 12 months, you probably knew that but I offer it for clarification.

The ATR and QM you mention seem to apply to Dodd Frank, there is a boat load of other regulations, Business Purpose seems to be an exemption for all of them, I'm guessing Bridge loan doesn't apply to all of them, maybe only DF.

I am a CA BRE Broker and only lend to rehabers, and only for 12mo or less, and am very careful about keeping to the business purpose.  Interesting about the bridge loan exemption, I didn't know about that.

I've used doc companies in the past, they seem to cost around $695 for a private money package.  I have my own (attorney approved) docs thus save.  If the doc company you know is good and less expensive I'd certainly be interested.  For the other readers, I'm guessing most if not all private money doc companies will only work with licensed individuals.

@David C.  The name of the company is Superior Loan Servicing.  I think the pricing they offer is very similar to what you quoted, and they also handle servicing and foreclosure services if needed.  There contact is below.

You are in pretty good shape if you are a CA BRE Broker like me, and use a good doc package.  Another thing is to monitor fire insurance and liens.  I recently had a situation where the borrower had a master insurance policy on several homes and it expired.  I thought we had set it up correctly for me to be notified, but I was not.  I ended up binding my own policy as the lender, but the home went quite a while with no fire insurance. That could have been a really bad situation!  

Scott Hacker / Superior Loan Servicin

(818) 483-0027 Phone

(888) 587-9757 Toll Free

@David Oldenburg

I get named as mortgagee on borrowers fire policy.  I have always gotten notified by the insurance company prior to cancellation or expiration, I think it's an insurance law that they can't cancel without notice.  I've had to step in and force place insurance as a lender.  I usually try to make payment on their existing policy before placing a new lender policy.  Lapsing fire insurance is one of those things that causes me a bit of anxiety at times.  Some loan servicing companies (including the one I'm with) won't monitor fire insurance, they see it as too much liability.  That in and of itself is an indication of the importance of monitoring fire insurance, I agree with you, it's important.

Not sure what you mean by monitoring liens.  I get a lenders policy at the get-go so I know my position, any lien subsequent is junior, this would be a red flag but not fatal.

Thanks for the doc service referral.

Originally posted by @Will Barnard :

One final thought: Usury laws are exempt in CA and many other states if a licensed broker is involved in the transaction.

 What if I live in CA and lend on a project in MD - to a broker from MD (who also is the one BRRRRing the deal)? Still limited to 10% or since he's "involved" in the transaction, will that work? Thanks!

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