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The following opinion is presented on-line for informational use only and does not replace the official version. (Mich Dept of Attorney General Web Site - www.ag.state.mi.us)



STATE OF MICHIGAN

FRANK J. KELLEY, ATTORNEY GENERAL


Opinion No. 6338

January 23, 1986

LAND CONTRACTS:

Late payment charges

USURY:

Impact of late payment charge upon maximum interest rate on land contract

Natural persons who are not regulated or approved lenders may enter into land contracts which provide a different rate of interest as a late payment charge in event of default, provided that the late payment charge is reasonably related to the expense of the inconvenience incurred by the land contract vendor.

Honorable Alan Cropsey

State Senator

The Capitol

Lansing, Michigan

You have requested my opinion on certain questions relating to MCL 438.31c(2); MSA 19.15(1c)(2), as it pertains to the amount of interest which may be charged on a land contract between natural persons who are not regulated lenders. Your questions are:

(1) May private individuals execute a land contract, consistent with MCL 438.31c(2); MSA 19.15(1c)(2), which provides for an initial rate of interest on the unpaid balance at 7% while the purchaser is not in default and further provides an interest rate of 8% on the unpaid balance for any period during which the purchaser is in default?

(2) Would it matter if the agreed upon initial interest rate was 11%, increasing to 12% if default occurs?

Since your questions are related, they will be considered simultaneously.

MCL 438.31c(2); MSA 19.15(1c)(2), as last amended by 1985 PA 7, reads in pertinent part:

'The parties to a note, bond, or other evidence of indebtedness, executed after August 11, 1969, the bona fide primary security for which is a first lien against real property, or a land lease if the tenant owns a majority interest in the improvements thereon, or the parties to a land contract, may agree in writing for the payment of any rate of interest, but the note, mortgage, contract, or other evidence of indebtedness shall not provide that the rate of interest initially effective may be increased for any reason whatsoever . . ..'

The basic issue is whether the prohibition against increasing the initial rate of interest is applicable to land contracts entered into by natural persons who are not regulated lenders.

The Michigan Court of Appeals considered this question in Patel v Holland, 114 Mich App 340, 346; 319 NW2d 553 (1982), lv den 417 Mich 926 (1983), and concluded loans made by persons who are not regulated lenders are exempt by virtue of MCL 438.31c(5); MSA 19.15(1c)(5), from the provisions of MCL 438.31c(2); MSA 19.15(1c)(2). The majority of the court concluded that the nonescalation of interest provisions of subsection (2) is inapplicable to land contracts between natural persons who are not regulated or approved lenders. It is noted that subsection (5) was amended by 1985 PA 7 to read:

'The provisions of subsection (2) shall apply only to loans made by lenders approved as a mortgagee under the national housing act, chapter 847, 48 Stat. 1246, or regulated by the state, or by a federal agency, who are authorized by state or federal law to make such loans.'

Such natural persons must make secured loans under subsection (6) of MCL 438.31c; MSA 19.15(1c). That subsection reads:

'Notwithstanding subsection (5), lenders or vendors not qualified to make loans under subsection (5) may make, or may have made, mortgage loans and land contracts specified in subsection (2) on or after August 16, 1971, which mortgage loans and land contracts provide for a rate of interest not to exceed 11% per annum, which interest shall be inclusive of all amounts defined as the 'finance charge' in the truth in lending act . . ..'

Thus, the natural persons entering into land contracts are subject only to the limitations of subsection (6).

The above statutory provision clearly sets forth a ceiling of 11% interest for all land contracts entered into between natural persons who are not regulated or approved lenders. Subsection (6) also provides that the 11% cap shall be inclusive of all 'finance charges' as contemplated by the Truth in Lending Act, 15 USC 1601 to 1667e and the regulations promulgated thereunder.

In light of the above, it is, therefore, necessary to determine whether or not a late charge provision in a land contract between private parties constitutes a 'finance charge' as envisioned by the Truth in Lending Act. If the answer to the above issue is in the affirmative, a late charge provision which increases the initial rate of interest from 11% to 12% would be violative of MCL 438.31c(6); MSA 19.15(1c)(6).

As previously stated in OAG, 1981-1982, No 5,904, p 199, 200 (May 15, 1981), 12 CFR Sec. 226.4(c), a regulation promulgated under the Truth in Lending Act resolves the issue regarding late payment charges by holding:

'A late payment, delinquency, default, reinstatement or other such charge, is not a finance charge if imposed for actual unanticipated late payment, delinquency, default or other such occurrence.' (Emphasis added.)

Therefore, since a late charge is not a 'finance charge,' as contemplated by the Truth in Lending Act, such provision will not affect the initially agreed upon rate of interest in the land contract instrument. To that end, it is of little consequence that that provision temporarily provides for an increase in interest from 11% to 12% as opposed to one of 7% to 8%. It is noted that natural persons are limited to 11% maximum interest and may charge reasonable late charges in the event of nonpayment.

OAG, 1981-1982, No 5,904, also clarified the distinction between a late payment charge and an illegal penalty:

'I . . . conclude that a late payment charge, required under the terms of a land contract between two individuals, does not constitute interest subject to the statutory interest rate ceiling for land contracts if such charge is imposed for actual unanticipated late payment, delinquency, default or other such occurrence. It must be stressed that the amount of the late payment charge must be reasonable, reflecting the expense of the inconvenience incurred, so as not to constitute a penalty which would be unenforceable at law. Curran v Williams, 352 Mich 278; 89 NW2d 602 (1958).'

It is my opinion, therefore, that natural persons who are neither regulated nor approved lenders may enter into land contracts which provide a different rate of interest as a late payment charge in the event of default, provided that such late payment on the unpaid balance charge is reasonably related to the expense of the inconvenience incurred by the land contract vendor.

Frank J. Kelley

Attorney General


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