Yes, it is legal to lend money with interest in the United States, but every state sets a maximum rate you can charge, and going over that ceiling can cost you the interest, the principal, or in extreme cases your freedom. The interest you collect is also taxable income, and if you charge a family member too little, the IRS may tax you on interest you never actually received. Before you hand over the money, you need to know your state’s cap, put the agreement in writing, and understand how the tax rules treat what you charge.
Your State Sets the Interest Rate Ceiling
Usury is the practice of charging interest above the legal limit, and those limits are written by states rather than the federal government. Each state writes its own cap and its own penalties for violations.1Legal Information Institute. Usury A rate that’s legal in one state can be a criminal offense in another.
The spread is wide. Some states cap general consumer loans at rates as low as 5%; others allow rates above 30%. A handful tie their caps to a variable benchmark, so the ceiling moves over time. The legal rate also depends on the type and size of the loan: small-dollar personal loans, larger consumer loans, and commercial transactions can each carry different limits within the same state.2Conference of State Bank Supervisors. CSBS Releases Comprehensive State Usury Rate Tool
Look up your state’s cap before you agree on a rate with the borrower. Search your state’s name plus “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 take your cue from the rate on a bank loan or credit card. Federal law preempts state usury limits in narrow situations, most notably first-lien residential mortgages made by federally regulated lenders,3eCFR. 12 CFR Part 190 – Preemption of State Usury Laws and those preemptions don’t extend to an individual lending personal funds.
What Happens If You Charge Too Much
Usury penalties are deliberately lopsided against the lender. The specifics vary by state, but they follow a few common patterns.
- Forfeiture of interest. The most common penalty strips the lender of the right to collect any interest at all. Under the federal banking statute, a national bank that knowingly charges above the legal rate forfeits the entire interest on the loan, and many state statutes apply the same rule to private lenders.4Office of the Law Revision Counsel. 12 USC 86 – Usurious Interest; Penalty for Taking; Limitations
- Double damages. Some states let the borrower recover twice the interest already paid. The federal statute allows the same recovery if the borrower sues within two years.4Office of the Law Revision Counsel. 12 USC 86 – Usurious Interest; Penalty for Taking; Limitations
- Loss of principal. In the harshest states, a court can void the entire loan, meaning you lose not just the interest but the right to get the original money back.
- Criminal exposure. Extreme cases can be prosecuted as misdemeanors or felonies at the state level. Federal law targets the predatory end: making a loan under conditions where the borrower reasonably believes nonpayment could result in violence carries up to 20 years in prison, and a debt at twice the enforceable rate can qualify as an “unlawful debt” under RICO with its own criminal and treble-damages exposure.5Office of the Law Revision Counsel. 18 USC 892 – Making Extortionate Extensions of Credit6Congress.gov. RICO: A Sketch
When in doubt, set your rate well below the state cap rather than testing the boundary. The legislature has decided the lender bears the risk of getting it wrong.
The IRS Taxes the Interest You Charge
Interest you receive on a private loan is taxable income. It doesn’t matter whether the borrower is your cousin or a stranger, and it doesn’t matter whether anyone issues you a Form 1099-INT. The IRS is explicit that you must report all interest income even if you don’t receive a form.7Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses Most individual lenders use cash-method accounting, meaning you report the interest in the year you actually receive it. A lump-sum payoff at the end of a multi-year loan is reported in the year of payment.
Report interest on line 2b of Form 1040. If your total taxable interest for the year exceeds $1,500, complete Schedule B as well.7Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Charging Too Little Also Costs You
Charging a below-market rate, or no interest at all, doesn’t avoid tax. If your rate falls below the Applicable Federal Rate (AFR) published monthly by the IRS, the difference is treated as “forgone interest”: the IRS pretends you gave that amount to the borrower and the borrower paid it back to you as interest, so you owe income tax on interest you never actually received.8Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates The AFR has three tiers based on how long the loan runs: short-term (three years or less), mid-term (over three but not over nine), and long-term (over nine). Check the current month’s AFR before you set your rate.9Internal Revenue Service. Applicable Federal Rates (AFRs) Rulings
There is one escape valve. 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. That exception disappears if the borrower uses the proceeds to buy income-producing assets like stocks or rental property.8Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates A $9,000 interest-free loan to help a sibling with a medical bill is fine; the same loan used to open a brokerage account is not.
Put the Loan in Writing
A handshake loan is a dispute waiting to happen. The single most important step you can take as a private lender is a promissory note, a signed document in which the borrower promises to repay a specific sum under specific terms.10Legal Information Institute. Promissory Note Without one, proving the loan exists is difficult if the borrower stops paying and you need to sue.
A solid promissory note includes:
- Full legal names and addresses for both lender and borrower.
- The exact principal amount being lent.
- The annual interest rate and how interest is calculated (simple or compound).
- The repayment schedule: payment amount, due dates, and final maturity date.
- Any late fees or penalty interest for overdue payments.
- The date of the loan and signatures of both parties.
Consider adding an acceleration clause, which 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. Most acceleration clauses don’t trigger automatically; you have to choose to invoke the clause after a default, and if the borrower cures the default first you generally lose the right to accelerate.11Legal Information Institute. Acceleration Clause
A promissory note usually doesn’t legally require notarization, but the small fee (typically $2 to $15) buys you a witness that both parties appeared in person and signed voluntarily, which makes it harder for the borrower to later claim forgery or duress. If you and the borrower live in different states, include a choice-of-law clause specifying which state’s law governs. Courts generally honor these provisions as long as the chosen state has a reasonable connection to the parties or the transaction. Without one, you may end up litigating which state’s usury limits apply before you even reach the merits.
Adding Collateral
An unsecured loan depends entirely on the borrower’s willingness and ability to pay. If you want a legal claim to specific property in case of default, you need a security interest and you have to take the right steps to make it enforceable against third parties.
For real estate, the borrower signs a mortgage or deed of trust (the terminology depends on the state) and you record it with the county recorder’s office. Recording puts the world on notice of your lien and protects your position if the borrower tries to sell the property or takes on other debts. Recording fees generally range from about $10 to $80 per document.
For personal property like a vehicle or equipment, you need a written security agreement describing the collateral and then file a UCC-1 financing statement with the appropriate state office, usually the secretary of state. The security agreement creates the interest; the UCC-1 gives public notice and establishes your priority over later creditors. Filing fees generally run $5 to $40.
When Lending Becomes a Business
Making a single loan to a friend or family member is one thing. Making loans regularly starts to look like a lending business, and most states require anyone “in the business of” making loans to obtain a license. The threshold for what counts as a business varies by state, but lending without a required license can void the loan and expose you to civil penalties or criminal charges. If you’re thinking about more than an occasional private loan, check with your state’s department of financial institutions before you proceed. The federal Truth in Lending Act adds another tripwire, imposing disclosure requirements on anyone who regularly extends consumer credit.
Don’t Sit on a Default
Every state sets a deadline for filing a lawsuit to collect on a debt, and written promissory notes generally get the longest window. Once that period expires, the debt is time-barred: the borrower can raise the expired deadline as a complete defense if you sue. The debt itself doesn’t vanish, and you can still ask the borrower to pay voluntarily, but you lose the ability to enforce it in court. The clock typically starts running from the date of the last missed payment or the maturity date, depending on the state. Waiting years to act is how lenders lose enforceable claims.