Are High Daily Interest Rates and Upfront Deductions by Online Lenders Legal in the Philippines?

Introduction

In the digital age, online lending platforms have proliferated in the Philippines, offering quick and convenient access to credit through mobile apps and websites. These platforms often target underserved populations, such as low-income earners and those without traditional banking access. However, concerns have arisen regarding their practices, particularly the imposition of high daily interest rates and upfront deductions from loan proceeds. These practices can lead to effective annual interest rates (EAR) that far exceed conventional norms, trapping borrowers in cycles of debt.

This article examines the legality of such practices within the Philippine legal framework. It draws on relevant statutes, regulations, judicial precedents, and regulatory guidelines to provide a comprehensive analysis. While the suspension of usury laws has liberalized interest rate agreements, protections against unconscionable rates and deceptive practices remain robust. The discussion is confined to the Philippine context, emphasizing consumer protection, regulatory oversight, and remedies available to borrowers.

Legal Framework Governing Interest Rates in Loans

The Philippine legal system regulates interest rates through a combination of civil law principles, statutory enactments, and regulatory issuances. Key provisions include:

Civil Code Provisions

The Civil Code of the Philippines (Republic Act No. 386, as amended) forms the foundational law on contracts, including loans. Under Article 1956, interest on loans is only due if stipulated in writing. Absent such stipulation, no interest accrues. However, when interest is agreed upon, it must not violate public policy or morals (Article 1306).

Article 2209 provides for legal interest in cases of delay or indemnity, currently set at 6% per annum by Bangko Sentral ng Pilipinas (BSP) Monetary Board Resolution No. 796 dated May 16, 2013, down from the previous 12%. This rate applies to forbearance of money unless otherwise stipulated.

Importantly, the Civil Code does not impose a fixed ceiling on stipulated interest rates, but contracts with rates that are "iniquitous or unconscionable" may be declared void or reformed by courts under Article 1409 (on unenforceable contracts) and Article 1413 (on reformation).

Suspension of the Usury Law

The Usury Law (Act No. 2655, as amended) originally capped interest rates at 12% per annum for secured loans and 14% for unsecured ones. However, Central Bank Circular No. 905-82, issued on December 22, 1982, suspended these ceilings to promote a free-market approach to lending. This liberalization allows lenders and borrowers to negotiate interest rates freely, subject to the condition that they are not "shocking to the conscience" or contrary to morals.

Subsequent BSP circulars, such as Circular No. 799 series of 2013, reaffirmed the legal interest rate but did not reinstate usury ceilings. Thus, while high rates are not per se illegal, they are scrutinized for fairness.

Truth in Lending Act (Republic Act No. 3765)

Enacted in 1963, this law mandates full disclosure of all finance charges in credit transactions. Section 4 requires lenders to furnish borrowers with a clear statement of:

The cash price or delivered price of the property or service.
Amounts credited as down payment or trade-in.
Charges not incident to the extension of credit.
Total amount to be financed.
Finance charges expressed in pesos and centavos.
Effective interest rate (EIR) or annual percentage rate (APR).

Non-compliance renders the lender liable for penalties, including fines up to PHP 100,000 or imprisonment, and allows borrowers to recover twice the finance charge paid.

For online lenders, disclosures must be made prior to loan consummation, typically via app interfaces or emails. High daily rates must be transparently converted to EIR for borrower understanding.

Consumer Act of the Philippines (Republic Act No. 7394)

This 1992 law protects consumers from deceptive, unfair, and unconscionable sales acts. Article 52 prohibits "unconscionable sales acts," including terms that are grossly one-sided or take advantage of consumer ignorance. High interest rates could fall under this if they exploit vulnerability.

The Department of Trade and Industry (DTI) enforces this act, with penalties including fines up to PHP 300,000 and imprisonment.

High Daily Interest Rates: Legality and Limits

Online lenders often advertise rates as "daily" (e.g., 0.5% to 2% per day) to appear modest, but these compound to astronomical annual rates. For instance:

1% daily interest equates to approximately 365% per annum (simple) or over 3,000% if compounded daily.
Short-term loans (e.g., 7-30 days) amplify this, as the effective rate skyrockets.

Are Such Rates Legal?

Post-Usury Law suspension, no statutory cap exists, but judicial intervention is possible. The Supreme Court has consistently held that interest rates must not be unconscionable. Key doctrines include:

Freedom of Contract vs. Public Policy: In Chua v. Timan (G.R. No. 170452, August 13, 2008), the Court upheld that parties can stipulate any rate, but if "iniquitous," it may be reduced equitably.
Unconscionable Rates Defined: No fixed threshold, but precedents provide guidance:
- In Medel v. Court of Appeals (G.R. No. 131622, November 27, 1998), 5.5% monthly (66% annually) was deemed unconscionable.
- In Spouses Solangon v. Salazar (G.R. No. 125944, August 29, 2002), 6% monthly (72% annually) was reduced to 1% monthly.
- In DBP v. Court of Appeals (G.R. No. 118342, January 5, 1998), rates exceeding 3% monthly have been struck down.
- More recently, in Advocates for Truth in Lending, Inc. v. Bangko Sentral Monetary Board (G.R. No. 192986, January 15, 2013), the Court affirmed the suspension of usury but emphasized equity.

For daily rates, if the EIR exceeds 30-50% annually (based on case patterns), courts may intervene, especially for consumer loans. Online lenders' rates often hit 200-1,000% EIR, rendering them presumptively unconscionable.

Compounding and Calculation

Interest may be simple or compounded. Article 1959 of the Civil Code allows compounding only if stipulated and unpaid interest is capitalized. Online platforms must disclose compounding methods under the Truth in Lending Act. Failure to do so can invalidate the interest clause.

Upfront Deductions: Practices and Legality

Upfront deductions involve subtracting fees, interest, or charges from the loan principal before disbursement. For example, a PHP 10,000 loan might disburse only PHP 8,000 after deducting PHP 2,000 in "processing fees" or advance interest.

Legal Assessment

As Advance Interest: Permissible if stipulated and disclosed (Civil Code Article 1958). However, it effectively increases the EIR, as interest is charged on the full principal but disbursed net.
As Fees: Allowed under BSP regulations for legitimate costs (e.g., documentation, credit checks). But excessive or hidden fees violate the Truth in Lending Act.
Unconscionability: If deductions reduce proceeds by 20-50% (common in online lending), it may be deemed a "loan sharking" tactic. In Ruiz v. Court of Appeals (G.R. No. 146942, April 22, 2003), the Court voided similar arrangements as usurious in effect.

The SEC Memorandum Circular No. 18 series of 2019 requires online lenders to disclose all fees upfront and prohibits "predatory" deductions that mislead borrowers about the true cost.

Regulation of Online Lenders

Online lending falls under multiple regulators:

Securities and Exchange Commission (SEC)

Under the Lending Company Regulation Act of 2007 (Republic Act No. 9474), all lending companies must register with the SEC. Online platforms are classified as "financing companies" if they extend credit via technology.

SEC Memorandum Circular No. 19 series of 2019 sets guidelines for fair debt collection, prohibiting harassment.
A moratorium on new online lending registrations was imposed in November 2019 due to abuses, lifted partially in 2021 with stricter vetting.
Unregistered lenders are illegal, and their contracts may be void (SEC vs. various apps, e.g., enforcement actions against over 2,000 unregistered entities by 2023).

Bangko Sentral ng Pilipinas (BSP)

Oversees banks and quasi-banks. Some online lenders partner with BSP-licensed entities. BSP Circular No. 1133 series of 2021 enhances consumer protection in digital financial services, mandating fair pricing.

National Privacy Commission (NPC)

Addresses data privacy breaches, common in online lending apps that access contacts for collection. Republic Act No. 10173 (Data Privacy Act) imposes penalties for unauthorized data use.

Other Agencies

DTI for consumer complaints.
Philippine National Police (PNP) and National Bureau of Investigation (NBI) for criminal cases involving fraud or estafa.

By 2025, regulatory crackdowns have led to the shutdown of hundreds of apps, with ongoing Senate inquiries into predatory lending.

Consumer Rights and Remedies

Borrowers facing high rates or deductions have several avenues:

Administrative Complaints:
- File with SEC for unregistered lenders or violations.
- BSP for supervised entities.
- DTI under the Consumer Act.
Civil Actions:
- Sue for reformation of contract or damages in Regional Trial Courts.
- Recover excess interest paid (Truth in Lending Act allows double recovery).
Criminal Prosecution:
- Estafa (Article 315, Revised Penal Code) if deception is involved.
- Violations of RA 3765 or RA 9474 carry fines and imprisonment.
Class Actions: Possible under Supreme Court rules for widespread abuses.

Organizations like the Credit Information Corporation (CIC) provide credit reports to help borrowers monitor impacts.

Judicial Precedents and Case Studies

Supreme Court decisions illustrate application:

Macalalag v. People (G.R. No. 164358, December 20, 2006): Reduced 10% monthly rate to 3%.
Recent cases involving online lenders (e.g., SEC enforcement against apps like Cashwagon, 2020) highlight invalidation of high-rate contracts.
In 2022-2024, courts handled class suits against platforms with 1-2% daily rates, often ruling them unconscionable.

Conclusion

High daily interest rates and upfront deductions by online lenders are not outright illegal in the Philippines due to the suspension of usury laws, but they are heavily regulated and often deemed unconscionable if excessive or undisclosed. Borrowers must receive transparent disclosures, and lenders must be registered. Practices leading to EIRs above 50-100% annually risk judicial nullification, with remedies available through regulatory bodies and courts.

To mitigate risks, consumers should verify lender registration via SEC/BSP websites, read terms carefully, and report abuses promptly. Policymakers continue to refine regulations, potentially reinstating caps or enhancing disclosures, to balance financial inclusion with protection. Ultimately, while innovation in lending is encouraged, it must not come at the expense of equity and fairness.