Are loan costs tied to CD rates?

Don Taylorq_v2.gifDear Dr. Don,
I have been in banking for 28 years and never had this question asked: "Is it a federal law that banks cannot lend at an interest rate that is more than 2 percent above its CD yield?"

My response was we can charge whatever we choose as long as it does not exceed usury rates. I realize competition keeps us in the 2 percent to 3 percent over range, but with rates at historical lows, our bank instituted a 6 percent floor. What's your response?
-- Keith Credit

a_v2.gifDear Keith,
It's a complicated area of the law. States do have usury laws that limit the rate of interest on loans. A state may also have a legal rate. The "Lectric Law Library" has a comprehensive discussion of these rates on its Web site. But you shouldn't rely on the state information being current. Check with your state's banking commissioner for up-to-date usury and legal rates. The Conference of State Bank Supervisors has a directory that provides the contact information.

Not all loans fall under the usury or legal rate limitations. This excerpt from the Lectric Law Library Web site explains:

Banks have separate rules. In fact, due to high inflation, in 1980, the federal government passed a special law which allowed national banks (the ones that have the word "national" or the term "N.A." in their name, and savings banks that are federally chartered) to ignore state usury limits and pegged the rate of interest at a certain number of points above the federal reserve discount rate. In addition, specially chartered organizations like small loan companies and installment plan sellers (like car financing companies) have their own rules.

The Bankrate feature "Credit cards trump state usury law" provides additional depth on this issue. The Federal Reserve replaced its discount window lending program in 2003 with a program that provided primary and secondary credit lending. This forced states that based usury ceilings on the Federal Reserve discount rate to amend their usury ceilings.

I've seen references to "criminal usury limits" at rates of 25 percent to 30 percent, but nothing about loan rates being tied to the CD rates offered by a financial institution.

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Read more Dr. Don columns for additional personal finance advice. To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & Investing" or "Money."

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