Lending money and charging interest is legal in every U.S. state, provided the rate you charge stays at or below your state’s usury cap. Beyond that ceiling, you face penalties that can wipe out your interest, void the loan, or in extreme cases expose you to criminal liability. You also owe federal income tax on the interest you collect, and if you charge too little, the IRS may tax you on interest you never actually received.
Your State Sets the Ceiling
Usury is the practice of charging interest at a rate higher than the law allows, and usury law is almost entirely state law. Each state writes its own cap and its own penalties.1Legal Information Institute. Usury A rate that is unremarkable in one state can be a criminal offense in the next.
The spread is wide. Some states cap general consumer loans at rates as low as 5%; others allow rates above 30%. A handful tie the ceiling to a floating benchmark, so the legal maximum moves over time. Caps also often depend on the type and size of the loan, with different limits for small personal loans, larger ones, and commercial transactions.2Conference of State Bank Supervisors. CSBS Releases Comprehensive State Usury Rate Tool
Look up your state’s specific rule before you agree to a rate. Search your state’s name with “usury statute” or “legal interest rate limit.” The answer is usually on the state legislature’s website or the state department of financial institutions. Don’t reason from what a bank or credit card issuer charges: those lenders operate under rules and federal preemptions that don’t extend to individuals lending personal funds.
What Happens If You Charge Too Much
Usury penalties are designed to fall hard on the lender. The specifics depend on your state, but a few patterns repeat.
The most common penalty strips the lender of any right to collect interest at all. Under the federal banking statute, a national bank that knowingly charges above the legal rate forfeits the entire interest the loan carries, and many state statutes apply the same rule to private lenders. Some states go further and let the borrower recover double the interest already paid; the federal banking statute allows the same recovery if the borrower sues within two years.3Office of the Law Revision Counsel. 12 USC 86 – Usurious Interest; Penalty for Taking; Limitations In the harshest states, a court can void the loan entirely, meaning the lender loses the principal as well.
State criminal statutes may treat extreme usury as a misdemeanor or felony. Federal criminal exposure kicks in at the predatory end of the spectrum. The extortionate credit transactions statute punishes anyone who makes a loan under conditions where the borrower reasonably believes that failure to repay could result in violence or harm, with up to 20 years in prison. The interest rate does not have to be usurious for the statute to apply; the implicit or explicit threat tied to repayment is what matters.4Office of the Law Revision Counsel. 18 USC 892 – Making Extortionate Extensions of Credit
RICO adds another layer. A debt unenforceable under state or federal usury law counts as an “unlawful debt” under RICO when the rate charged is at least twice the enforceable rate, and collecting on that debt can trigger RICO liability without the pattern of racketeering activity normally required. Criminal penalties run up to 20 years and include forfeiture, while civil RICO lets the borrower recover triple damages plus attorney’s fees.5Congress.gov. RICO: A Sketch
The lesson from the penalty structure is simple: legislatures want lenders to carry the risk of getting the rate wrong. Set your rate comfortably below the state cap rather than testing it.
Interest You Receive Is Taxable Income
Every dollar of interest you collect on a private loan is taxable, whether the borrower is a stranger or a close relative, and whether or not you receive a Form 1099-INT. The IRS requires you to report all interest income even if no form is issued.6Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses Most individuals use the cash method, so you report interest in the year you actually receive it. If the borrower pays a lump sum of principal and interest at the end of a multi-year loan, the interest portion goes on that year’s return.
Report interest income on line 2b of Form 1040. Complete Schedule B if your total taxable interest for the year exceeds $1,500.6Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Charging Too Little: The Applicable Federal Rate
You cannot avoid tax by charging little or no interest. If the rate on your loan is below the Applicable Federal Rate (AFR), the IRS treats the difference as “forgone interest” and taxes you on it. The fiction is that you transferred the missing interest to the borrower as a gift, and the borrower then paid it back to you, so you owe income tax on interest you never actually collected.7Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
The AFR is published monthly and comes in three tiers by loan duration. In early 2026, the short-term rate (loans of three years or less) was around 3.6%, the mid-term rate (over three years but not over nine) around 3.8% to 3.9%, and the long-term rate (over nine years) around 4.6% to 4.7%.8Internal Revenue Service. Applicable Federal Rates (AFRs) Rulings Check the current month’s release before setting your rate.
The $10,000 Exception
There is one meaningful safe harbor. Gift loans directly between individuals are exempt from the imputed interest rules on any day the total outstanding balance between the two of you is $10,000 or less. The exception disappears if the borrower uses the proceeds to buy income-producing assets such as stocks or rental property.7Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates A $9,000 no-interest loan to help a sibling pay a medical bill stays clear; the same loan used to open a brokerage account does not.
Put the Loan in Writing
A handshake loan is the fastest route to a dispute you cannot win. Use a promissory note: a signed document in which the borrower promises to repay a specific sum under specific terms.9Legal Information Institute. Promissory Note Without one, proving the loan even exists becomes difficult if the borrower stops paying and you need to sue.
A workable promissory note covers:
- Full legal names and addresses of both parties.
- The exact principal amount.
- The annual interest rate and whether interest is simple or compound.
- The repayment schedule, including payment amounts, due dates, and the final maturity date.
- Any late fee or penalty interest for overdue payments.
- The date of the loan and the signatures of both parties.
Add an acceleration clause. It gives you the right to demand the entire remaining balance if the borrower defaults; without one, you can only sue for each missed payment as it comes due. Acceleration clauses generally don’t trigger automatically. The lender has to invoke the clause after a default, and if the borrower cures the default first, the right to accelerate is usually lost.10Legal Information Institute. Acceleration Clause
Notarization is not required in most situations, but it is worth the modest cost. A notary’s seal confirms that both parties appeared in person and signed voluntarily, which makes later claims of forgery or duress much harder to sustain. Notary fees for a single signature usually run between $2 and $15.
If you and the borrower live in different states, name the governing state law in the note. Courts generally honor a choice-of-law clause where the chosen state has a reasonable connection to the parties or the loan. Without one, you may end up fighting over which state’s usury limit applies before you get anywhere near the merits.
When Repeated Lending Becomes a Business
A single loan to a friend or relative is one thing. Making loans on a regular basis starts to look like a lending business, and most states require anyone “in the business of” making loans to hold a license. The threshold varies by state. Lending without a required license can void the loan, trigger civil penalties, and in some states carry criminal charges. If you’re contemplating more than an occasional private loan, check with your state’s department of financial institutions before you proceed. The federal Truth in Lending Act may also require formal disclosures once your lending is regular enough to qualify you as a “creditor.”
Don’t Wait Too Long to Collect
Every state sets a deadline for suing to collect on a debt, and written promissory notes generally get one of the longer windows. Once that period expires, the debt is “time-barred”: the borrower can raise the expired deadline as a complete defense, and you lose the ability to enforce the loan in court. The debt itself doesn’t disappear, and voluntary payment is still allowed, but your leverage is gone. On a multi-year repayment schedule, the clock typically runs from the date of the last missed payment or from the maturity date, depending on the state. Letting a default sit for years is how enforceable claims quietly become unenforceable ones.