As with so many of my blog posts, I like sharing some of my actual experiences with you because I believe experience is the best teacher. This one is an important reminder about the fact that note investing requires some serious due diligence before you jump in. Usury Laws! The term just rolls off the tongue right? Well, even though this is not the most glamorous aspect of note investing, it is important for every note investor to be knowledgeable about Usury Laws.
Usury Laws are federal and state laws that spell out how much interest can be charged on loans. There are usury laws that relate to all aspects of lending.
With that said, there are many variations and interpretations of the law depending on where you are, but for today here is an excellent starter guide to help you avoid making a costly mistake.
If you are selling properties on financing, you need to be aware of the usury laws in your state. For example, I was contacted this week by a note holder who wanted to sell me their Michigan land contract note. It carried an interest rate of 14%. The seller was quite proud of the fact that he got the loan signed for 14%. However, it didn’t take me long to figure out it was a ticking time bomb. Why? The interest rate violated state usury laws for seller financing as it relates to real estate. Michigan (not all states) has a cap of 11% on real estate financed transactions. That means, you as a note originator cannot originate a loan for more than 11%.
Yet, some investors would argue, it’s a contract between a buyer and seller and if the buyer agrees to the terms, the terms are in effect. That is true until, if, and when the buyer finds out you violated the law. As a “loan shark”, which you would become in the eyes of the courts, you would now face several severe penalties.
Potential Penalties for Being Deemed a “Loan Shark”
- The borrower bringing legal action for money damages for all money previously paid up to two years from the time of action.
- The buyer getting 3 times the interest paid during a one year period.
- The buyer gets all remaining interest due on the loan forfeited, resulting in an interest free loan.
Pretty harsh penalties to say the least, and there’s more . . . Damages can also include civil and criminal penalties, depending on the case. As with anything, it is best to consult with an attorney or specialist in your state to find out what the usury laws are in your specific area.
Now these guidelines are just as important for the note buyer. You take on the responsibilities and ownership of the note seller. If you buy a note that violates usury laws, you could be the one facing the penalties and be considered the loan shark! Therefore, it is important to know these laws as it relates to every aspect of your note investing career.
Usury laws are an important consideration in note investing because there are stiff penalties for those who violate the law…… unless you are a credit card company, but that is another post for another day!
Photo: Allan Lee