Legal Question in Business Law in California

A penalty fee that large is probably illegal as a forfieture, or usurey, or as an illegal liquidated damages clause, or many other grounds. But think about it, if they default on the loan and have no collateral, do you think they'll pay the 50% penalty? So why bother with an unenforceable provision of questionable legality.

I agree.......a 50% penalty would almost certainly be an unenforceable penalty. The law will enforce liquidated damages clauses in contracts only if they were reasonable estimates of actual damages at the time the contract was negotiated and actual damages would be hard to figure. Damages for non-repayment of a loan don't fall into the hard-to-figure category, and 50% sounds unreasonable per se.

Further, and possibly a greater problem, a 50% penalty likely would be usurious interest. The borrower could pay it, then turn around and sue you for treble damages.

What is the borrower going to do with the loan proceeds? If he's going to buy something substantial, maybe you could take a security interest in the thing bought. If you are currently concerned about being repaid, don't make an unsecured or under-secured loan to the person unless you can afford to take a loss and/or are willing to make a gift.

Penalties such as this are not enforceable. So, in the absence of collateral, you're probably better off requiring the borrower to have a co-signer, or have someone else give a personal guarantee.