Introduction

The proliferation of online lending applications in the Philippines has revolutionized access to credit, particularly for unbanked or underbanked individuals. These platforms offer quick loans through mobile apps, often without traditional collateral or extensive documentation. However, this convenience has been marred by complaints of predatory practices, including the imposition of closure fees (also known as prepayment penalties or early termination fees) and exorbitant interest rates. Borrowers frequently report being charged fees for settling loans ahead of schedule or facing effective annual interest rates that exceed reasonable bounds, leading to cycles of debt.

This article examines the legality of these practices within the Philippine legal framework. It explores relevant statutes, regulatory guidelines, judicial interpretations, and consumer protections. While online lending apps provide financial inclusion, their operations must comply with laws designed to prevent usury, unfair contracts, and exploitation. Understanding these rules is crucial for borrowers, lenders, and regulators alike.

Legal Framework Governing Lending in the Philippines

Lending activities in the Philippines are regulated by a combination of civil laws, special statutes, and administrative issuances. The primary sources include:

Civil Code of the Philippines (Republic Act No. 386): This foundational law governs contracts, including loan agreements (mutuum). Articles 1956 to 1961 address interest on loans, while Articles 1305 to 1422 deal with contract validity, consent, and obligations. Key principles include freedom of contract (Article 1306), but with limitations against contracts contrary to law, morals, good customs, public order, or public policy (Article 1306).
Lending Company Regulation Act of 2007 (Republic Act No. 9474): This mandates that all lending companies, including those operating online, register with the Securities and Exchange Commission (SEC). It empowers the SEC to regulate lending practices to ensure fairness and transparency.
Truth in Lending Act (Republic Act No. 3765): Requires lenders to disclose all finance charges, interest rates, and fees upfront in a clear manner. Non-compliance can render charges unenforceable.
Consumer Act of the Philippines (Republic Act No. 7394): Protects consumers from deceptive, unfair, and unconscionable sales acts or practices, including in credit transactions.
SEC Regulations: The SEC has issued specific guidelines for online lending platforms. Memorandum Circular No. 19, Series of 2019, outlines fair lending practices, prohibiting harassment, requiring data privacy compliance, and mandating transparent fee structures. It also requires online lenders to secure a Certificate of Authority (CA) from the SEC.
Bangko Sentral ng Pilipinas (BSP) Oversight: While the BSP primarily regulates banks, it collaborates with the SEC on fintech issues. Circular No. 1108, Series of 2021, addresses digital financial services, emphasizing consumer protection.

Online lending apps fall under "fintech" or "digital lending" categories. Only SEC-registered entities can legally operate, and unregistered ones are considered illegal, subjecting them to penalties under RA 9474.

What Are Closure Fees?

Closure fees, in the context of online lending apps, refer to charges imposed on borrowers who repay their loans before the maturity date. These may be labeled as "prepayment penalties," "early settlement fees," or "termination charges." Lenders justify them as compensation for lost interest income or administrative costs associated with early closure. In practice, these fees can range from a flat amount to a percentage of the outstanding principal, sometimes making early repayment more expensive than carrying the loan to term.

For example, a borrower might face a 5-10% fee on the remaining balance if they settle a loan midway. This practice is common in short-term, high-interest loans offered by apps, where loan terms are often 7-30 days.

Legality of Closure Fees

The legality of closure fees hinges on contractual freedom balanced against protections against unconscionable terms.

Contractual Basis: Under Article 1308 of the Civil Code, parties may stipulate penalties for breach or early termination, provided they are not contrary to law. If a loan agreement explicitly includes a closure fee and the borrower consents, it is prima facie valid.
Limitations and Prohibitions: However, such fees must not be excessive or punitive. Article 1229 allows courts to reduce penalties if they are "iniquitous or unconscionable." Supreme Court rulings, such as in Spouses Silos v. Philippine National Bank (G.R. No. 181045, 2011), emphasize that penalties serving as disguised interest must be reasonable.
Specific to Lending: The Truth in Lending Act requires full disclosure of such fees. Failure to disclose renders them void (Section 4). SEC Memorandum Circular No. 19 prohibits "unfair collection practices" and mandates that all fees be "reasonable and transparent." The SEC has flagged closure fees in online apps as potentially abusive if they deter borrowers from escaping debt traps.
Judicial Scrutiny: In cases like DBP v. Mirang (G.R. No. L-34482, 1975), the Court invalidated excessive penalties. For online apps, the Department of Trade and Industry (DTI) and National Privacy Commission (NPC) have investigated complaints, leading to cease-and-desist orders against apps imposing hidden or exorbitant closure fees.
Regulatory Actions: The SEC has revoked CAs of non-compliant lenders. As of recent enforcement, apps must cap ancillary fees and ensure they do not exceed the cost of services rendered. Borrowers can challenge closure fees as usurious if they effectively inflate interest rates.

In summary, closure fees are legal if disclosed, consented to, and reasonable. Excessive or undisclosed fees are illegal and unenforceable.

Excessive Interest: Definition and Legality

Excessive interest refers to rates that are unconscionably high, often exceeding market norms or leading to borrower exploitation. Online lending apps frequently advertise low nominal rates but impose effective rates (including fees) that can reach 100-500% annually.

Historical Context: The Usury Law (Act No. 2655) once capped interest at 12-14% per annum, but Central Bank Circular No. 905, Series of 1982, suspended these ceilings, allowing market-determined rates.
Current Standard: Without a statutory cap, interest is governed by mutual agreement (Civil Code, Article 1956). However, rates must not be "shocking to the conscience." Supreme Court decisions define "unconscionable" interest as rates over 3% per month or 36% per annum, depending on circumstances (Macalinao v. Bank of the Philippine Islands, G.R. No. 175490, 2009; Chua v. Timan, G.R. No. 170452, 2008).
Effective Interest Rate (EIR): The Truth in Lending Act requires disclosure of EIR, which includes all charges. Online apps often hide EIR through "service fees" or "processing charges," making nominal rates appear low (e.g., 1% daily, equating to 365% annually).
SEC Guidelines: Memorandum Circular No. 19 caps effective interest at levels deemed fair, though not numerically fixed. It prohibits "predatory pricing." The SEC monitors apps for rates exceeding 1-2% daily, considering them prima facie excessive.
Consumer Protection: Under the Consumer Act, excessive interest constitutes an "unconscionable sales act" (Article 52). Borrowers can seek annulment of contracts under Article 1409 of the Civil Code if rates violate public policy.
Case Law Examples:
- Advincula v. Advincula (G.R. No. L-24384, 1968): Interest over 6% monthly was voided.
- Spouses Prado v. Spouses China Banking Corp. (G.R. No. 175422, 2012): Courts reduced rates from 3% monthly to 1%.
- Recent fintech cases: The Supreme Court in SEC v. Various Online Lending Platforms (administrative, not judicial) supported crackdowns on apps with 20-30% monthly rates.
Compounding and Other Practices: Compounded interest must be stipulated (Article 1959). Daily compounding in apps can exponentially increase debt, often ruled unconscionable.

Excessive interest is illegal if unconscionable, even if agreed upon. Courts prioritize equity, especially for vulnerable borrowers.

Regulatory Enforcement and Challenges

The SEC, in partnership with the BSP and DTI, has intensified oversight. By 2023-2025, over 2,000 illegal apps were blacklisted via the SEC's "Labanan ang Online Lending Abuse" campaign. Registered apps must adhere to a Code of Conduct, including interest caps inferred from fair practice rules.

Challenges include:

Jurisdictional Issues: Many apps are foreign-owned, complicating enforcement.
Data Privacy Violations: High-interest apps often misuse personal data under RA 10173 (Data Privacy Act).
Borrower Awareness: Many users accept terms without reading, weakening consent defenses.

Remedies for Affected Borrowers

Borrowers facing illegal fees or interest can:

File complaints with the SEC via its Enforcement and Investor Protection Department.
Seek DTI mediation under the Consumer Act.
Initiate civil actions for contract annulment, damages, or restitution (Civil Code, Articles 19-21 on abuse of rights).
Report to the NPC for privacy breaches.
Class actions are possible for widespread abuses.

Successful complainants may recover overpaid amounts, with lenders facing fines up to PHP 1 million or imprisonment under RA 9474.

Conclusion

Closure fees and excessive interest by online lending apps are not inherently illegal in the Philippines but are strictly regulated to prevent abuse. They must be transparent, reasonable, and consensual, aligning with civil law principles and SEC guidelines. Unconscionable practices violate consumer rights and can lead to contract invalidity, regulatory sanctions, and judicial intervention. As fintech evolves, borrowers should verify lender registration, scrutinize terms, and report violations. Regulators continue to adapt, but ultimate protection lies in informed borrowing and robust enforcement. This balance ensures financial inclusion without exploitation.