The IRS sets a floor on family loan interest through the Applicable Federal Rate, but almost nobody mentions the other boundary: a ceiling set by your state, not the federal government. Charge too little and the IRS treats the difference as a taxable gift. Charge too much and your state's usury law can void the interest, or in rare cases the entire loan. The maximum interest rate you can charge on a family loan is whichever is lower, the rate your state allows or the rate the two of you agree to, and the two limits come from completely different legal systems.
Most families never get near either edge. A parent charging 4% on a $30,000 loan to a child is nowhere close to a usury violation in any state. The risk shows up when someone tries to treat a family loan like a hard-money loan, pricing it at 15% or 18% to compensate for the risk of lending to a relative with shaky credit. That's exactly the rate range where state usury caps start to bite.
How much interest can you legally charge on a family loan?
Usury statutes exist to stop lenders from charging exploitative interest rates, and unlike the Applicable Federal Rate, they are set state by state, not federally. Banks, credit unions, and most licensed commercial lenders are exempt or operate under separate rate structures. A private loan between two individuals, which is exactly what a family loan is, usually is not exempt.
That distinction matters because family lenders sometimes assume that because they are not a "real" lender, consumer lending rules do not apply to them. The opposite is closer to true: usury law is aimed specifically at unlicensed, informal, individual-to-individual lending, which is the category a family loan falls into by default.
Three states illustrate how differently this plays out:
| State | Cap for a private, personal-use loan | Source |
|---|---|---|
| California | 10% per year for loans used primarily for personal, family, or household purposes | Cal. Const. art. XV, § 1 |
| Washington | 12% per year, or 4 points above the prior month's 26-week Treasury bill rate, whichever is higher | Revised Code of Washington, via the Washington Department of Financial Institutions |
| Utah | No statutory ceiling. Parties can contract for any rate in writing; the default legal rate if none is specified is 10% | Utah Code § 15-1-1 |
That range, from a hard 10% ceiling to no ceiling at all, is the point. You cannot borrow a number from a blog post written for a different state and assume it applies to your loan. The controlling law is typically the state named in your promissory note, or if the note is silent, the state where the loan was made or where the borrower resides, and courts do not always agree on which. If you are pricing a loan above roughly 10% and the amount is meaningful, that is the moment to have a local attorney confirm which state's law governs and what its cap is, not after a dispute starts.
Why the maximum interest rate on a family loan rarely collides with the IRS floor
Family Loan Tracker's guide to what interest rate to charge on a family loan walks through the other boundary: the Applicable Federal Rate, the minimum rate the IRS expects on a loan of a given term before it starts treating forgone interest as a taxable gift to the borrower under the imputed interest rules. AFRs move monthly and have sat in the low single digits for most maturities in recent years. You can check the current published rates with Family Loan Tracker's AFR and minimum interest calculator, which pulls the live IRS table instead of a number that goes stale the month after it is published.
Because AFRs run so far below every state's usury ceiling, a family loan priced at or even a few points above the AFR essentially never triggers a usury problem. The floor and the ceiling are usually many percentage points apart, with an enormous safe zone between them. The two rules only start to matter for the same loan when a family lender pushes the rate up deliberately, often to compensate for a borrower's poor credit or to make the loan feel more like a market-rate investment than a favor.
What happens if you charge more than your state's usury limit?
The consequences for exceeding a state's usury cap vary by state, and they are more severe than a warning letter:
- Forfeiture of interest. The most common penalty. The lender keeps the principal but loses the right to collect interest above (sometimes at all above) the legal rate.
- Forfeiture of a multiple of the interest. Some states require the lender to return double or triple the interest already collected.
- Forfeiture of the entire debt. A minority of states allow a court to void the loan entirely, meaning the borrower owes nothing, not even the principal, if the usury violation is severe enough.
- Unenforceability in court. Even where the penalty is not automatic, a lender trying to collect on a usurious note in a lawsuit can find the interest provision unenforceable, or the entire note challenged.
None of this requires the borrower to file a formal complaint first. Usury is typically raised as a defense when a family lender sues to collect an unpaid loan, which means the risk is invisible right up until the relationship breaks down and you need the courts.
A practical way to stay inside both lines
You do not need to become a conflicts-of-law expert to price a family loan safely. Three habits keep almost every family loan inside both boundaries:
- Anchor to the AFR, not a market comparison. Pricing off a "what would a bank charge this borrower" instinct is what pushes rates into usury territory. Anchoring to the published AFR for the loan's term keeps you well inside every state's cap while still avoiding imputed-interest exposure.
- Name the governing state in the note. A written family loan agreement that specifies which state's law governs removes the ambiguity that turns a rate dispute into a jurisdiction fight.
- Get a second opinion before pricing above roughly 10%. If you have a specific reason to charge more, perhaps to reflect real credit risk on a large loan, treat that as the trigger to consult a local attorney before you sign anything, not the IRS floor as your only checkpoint.
None of this is tax or legal advice, and usury statutes change and get reinterpreted by courts. Confirm the current cap and any exemptions in your specific state, or the state where your borrower lives, before finalizing a rate meaningfully above the AFR.
Ready to put a rate on paper the right way? Create a free family loan agreement that documents the rate, term, and governing state, or start tracking your loan once it's signed.
