Introduction

In the rapidly evolving landscape of financial technology in the Philippines, online lending applications have become a popular source of quick credit for individuals and small businesses. These platforms offer convenience through digital interfaces, minimal documentation, and fast disbursements. However, concerns have arisen regarding the imposition of closure fees—charges applied when a loan is paid off early or closed—and excessive interest rates that can trap borrowers in cycles of debt. This article examines the legality of these practices within the Philippine legal framework, drawing on relevant statutes, regulations, and jurisprudence. It explores whether such fees and rates comply with principles of fair lending, consumer protection, and contractual freedom, while highlighting the regulatory oversight by government bodies like the Bangko Sentral ng Pilipinas (BSP) and the Securities and Exchange Commission (SEC).

The discussion is grounded in the Philippine context, where the absence of a usury law since 1982 has shifted the focus from statutory caps on interest to judicial scrutiny of unconscionable terms. Online lending apps, often operated by financing companies or lending companies, must navigate a complex web of laws designed to prevent predatory practices while promoting financial inclusion.

Legal Framework Governing Lending Practices

The Philippine legal system provides a multifaceted regulatory environment for lending activities. Key laws include:

Civil Code of the Philippines (Republic Act No. 386): This foundational statute governs contracts, including loan agreements. Under Article 1306, parties may establish stipulations as they deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. This principle of contractual autonomy allows lenders to set interest rates and fees, but it is tempered by provisions against unconscionable contracts (Article 1409) and those that are void for being against public policy.
Truth in Lending Act (Republic Act No. 3765): Enacted in 1963, this law mandates full disclosure of all finance charges, including interest, fees, and other costs, before a loan is consummated. Section 4 requires lenders to furnish borrowers with a clear statement of the loan amount, finance charges, effective interest rate, and other terms. Violations can result in penalties, including fines and imprisonment, and may render the undisclosed charges unenforceable.
Lending Company Regulation Act of 2007 (Republic Act No. 9474): This act regulates lending companies, requiring them to register with the SEC and comply with disclosure requirements. It prohibits misleading advertisements and unfair collection practices, which indirectly impacts the transparency of fees and interest.
Financing Company Act (Republic Act No. 5980, as amended): Similar to the LCRA, this governs financing companies, many of which operate online lending platforms. It empowers the SEC to supervise these entities and ensure compliance with ethical standards.
Consumer Act of the Philippines (Republic Act No. 7394): Title III on Consumer Credit Transactions protects borrowers from deceptive practices, including hidden fees and exorbitant charges. It reinforces the need for transparency and fairness in credit extensions.
BSP Regulations: The BSP, as the central monetary authority, issues circulars governing banks and quasi-banks, but its oversight extends to non-bank financial institutions through moral suasion and specific guidelines. Notably, BSP Circular No. 730 (2011) and subsequent issuances emphasize fair treatment of financial consumers, including prohibitions on abusive practices.

In the context of online lending, the SEC has taken a proactive role. In 2019, it issued Memorandum Circular No. 19, series of 2019, requiring online lending platforms to register and adhere to fair lending practices. This was in response to widespread complaints about harassment, high interest, and opaque fees. The circular mandates clear disclosure of terms and prohibits interest rates that are "unfair or unconscionable."

Legality of Excessive Interest Rates

Historical Context and Absence of Usury Caps

Prior to 1982, the Usury Law (Act No. 2655) capped interest rates at 12% per annum for secured loans and 14% for unsecured ones. However, Central Bank Circular No. 905, series of 1982, suspended these ceilings, allowing market forces to determine rates. This deregulation aimed to encourage lending amid economic challenges but opened the door to potentially abusive rates.

Today, there is no statutory cap on interest rates in the Philippines. Lenders, including online apps, can charge rates based on agreement, but this freedom is not absolute. The Supreme Court has consistently held that while stipulated interest rates are prima facie valid, they may be declared void if proven unconscionable.

Judicial Scrutiny of Unconscionable Interest

Philippine jurisprudence defines "unconscionable interest" as rates that are excessive, iniquitous, or shocking to the conscience, rendering the contract voidable or the stipulation unenforceable. Key cases include:

Medel v. Court of Appeals (G.R. No. 131622, 1998): The Court struck down a 5.5% monthly interest rate (66% annually) on a loan, deeming it unconscionable. It emphasized that freedom of contract does not justify exploitation.
Chua v. Timan (G.R. No. 170452, 2007): A 7% monthly rate was reduced to 1% monthly, as it was found to be excessive under the circumstances.
Advincula v. Advincula (G.R. No. 190884, 2013): The Court reiterated that rates exceeding 3% monthly (36% annually) are presumptively unconscionable, though this is not a hard rule but depends on factors like borrower's sophistication, loan purpose, and market conditions.

For online lending apps, which often target low-income or unbanked individuals, rates can reach 1-5% per day, translating to annual percentage rates (APRs) of 365% to over 1,800%. Such rates have been challenged in courts and regulatory bodies. The SEC and BSP have investigated platforms like Cashwagon and Cashalo for rates deemed predatory, leading to suspensions and fines.

Compounding interest—calculating interest on interest—must also be disclosed. Under the Truth in Lending Act, failure to disclose the effective rate (including compounding) voids the interest stipulation.

Regulatory Interventions

In 2020, amid the COVID-19 pandemic, the SEC imposed a moratorium on new online lending registrations and cracked down on unregistered apps. BSP Circular No. 1133 (2021) introduced the Financial Consumer Protection Framework, requiring all supervised institutions to adopt fair pricing policies. Online lenders must now justify rates based on risk assessment, not exploitation.

Excessive interest may also violate anti-usury principles embedded in the Revised Penal Code (Article 315 on estafa), if it involves deceit, though this is rarely applied to contractual interest.

Legality of Closure Fees

Closure fees, also known as pre-termination fees, early settlement fees, or redemption fees, are charges imposed when a borrower repays a loan before its maturity date. These fees compensate lenders for lost interest income or administrative costs.

Contractual Basis

Under the Civil Code, such fees are permissible if stipulated in the contract and disclosed upfront, per the Truth in Lending Act. They must be reasonable and not punitive. Excessive closure fees could be deemed penalties that are unconscionable, similar to interest rates.

Regulatory Guidelines

BSP regulations for banks limit pre-termination fees to a reasonable amount, often 3-5% of the outstanding balance. For non-banks like online lenders, the SEC requires that fees be "fair and transparent." Memorandum Circular No. 19 (2019) specifically mandates disclosure of all fees, including closure charges, in the loan agreement.

In practice, some apps charge 5-20% of the loan amount as closure fees, which can erode the benefits of early repayment. If undisclosed or disproportionate, these fees may be unenforceable. The Consumer Act prohibits "unfair or deceptive acts" in credit transactions, which could encompass hidden closure fees.

Jurisprudential Insights

Cases like DBP v. Court of Appeals (G.R. No. 118342, 1996) upheld reasonable pre-termination fees but struck down those that were exorbitant. In the online lending sphere, consumer complaints to the SEC have led to refunds of improper fees, underscoring that closure fees must not defeat the purpose of borrowing—access to affordable credit.

Specific Issues with Online Lending Apps

Online lending apps often operate in a gray area, with some unregistered entities evading regulation. Common issues include:

Lack of Registration: Only SEC-registered lending or financing companies can legally operate. Unregistered apps (often foreign-owned) imposing high fees and interest are illegal ab initio.
Data Privacy and Harassment: While not directly related to fees and interest, abusive collection tied to high charges violates Republic Act No. 10173 (Data Privacy Act) and SEC rules.
Micro-Lending Focus: Apps targeting short-term, small loans (e.g., payday loans) amplify the impact of high rates and fees due to frequent rollovers.

Government responses include the creation of the Financial Products and Services Consumer Protection Act (Republic Act No. 11765, 2022), which strengthens remedies for consumers, including class actions against predatory lenders.

Remedies for Borrowers

Affected borrowers can:

File complaints with the SEC or BSP for regulatory action.
Seek judicial relief to declare stipulations void and recover overpayments.
Report to the National Privacy Commission for privacy breaches.
Utilize alternative dispute resolution under the Consumer Act.

Conclusion

In summary, closure fees and excessive interest by online lending apps are not inherently illegal in the Philippines but are subject to strict scrutiny for fairness, transparency, and conscionability. While contractual freedom allows flexibility, laws like the Truth in Lending Act, Civil Code, and regulatory circulars from the SEC and BSP ensure protection against abuse. Borrowers should demand full disclosure and challenge unconscionable terms through appropriate channels. As the fintech sector grows, ongoing reforms aim to balance innovation with consumer safeguards, fostering a more equitable lending environment. Policymakers continue to monitor these practices to prevent exploitation, emphasizing that legality hinges on adherence to ethical standards rather than mere technical compliance.