Debt Settlement Rules on Interest-Only Payments (Philippines)

A practitioner-oriented guide. General information only—not legal advice.

1) What “interest-only” means in Philippine practice

An interest-only arrangement is a restructuring or settlement where, for a defined period, the debtor pays interest as it accrues but does not amortize principal. It is common in:

Bridge loans and short-term working capital facilities
“Forbearance” periods during hardship or after default
Court-approved compromises to avoid immediate execution/foreclosure

Legally, it’s simply a modified mode of performance (often a modificatory novation) of an existing loan/credit, subject to general Civil Code rules on obligations and contracts, special disclosure rules for lenders, and sector-specific regulations.

2) Core legal pillars

Civil Code on obligations and loans (mutuum)
- Interest must be expressly stipulated in writing; otherwise no conventional interest is due (Art. 1956).
- Application of payments: if the debt produces interest, payment of principal shall not be deemed made until the interest has been covered (Art. 1253). This is the default rule unless parties validly re-arrange it.
- Interest on interest (compounding/anatocism): not allowed unless expressly stipulated; even then, courts may temper unconscionable compounding. Separately, legal interest can run on due and unpaid interest once judicially demanded (Art. 2212).
- Penalties and liquidated damages may be equitably reduced if iniquitous or unconscionable (Art. 1229).
- Novation: A restructuring is a novation only if there is clear intent (animus novandi) or incompatibility with the old terms (Arts. 1291–1292). Otherwise it’s merely a forbearance (same obligation, altered terms).
Usury law & rates
- Usury ceilings are not in force (ceiling provisions were suspended decades ago), but interest must still pass the Civil Code’s standards of reasonableness and equity. Courts routinely strike down or reduce excessive/unconscionable rates, penalties, or compounding—even if “agreed.”
Legal interest (judgment / forbearance interest)
- Monetary awards and loans earn legal interest at the prevailing single rate set by the Supreme Court framework (often called the Nacar rule):
  - Before finality: rate and accrual depend on whether the sum was liquidated and whether there was judicial or extrajudicial demand.
  - From finality of judgment until full satisfaction: a uniform legal rate applies.
- Parties should draft to avoid ambiguity about when default occurs and from what date interest runs.
Consumer protection & disclosure
- Truth in Lending Act (RA 3765): lenders must disclose finance charges and effective cost of credit (APR-style) before consummation; failure can attract administrative sanctions and support defenses/counterclaims.
- Lending Company Regulation Act (RA 9474) and Financing Company Act: govern licensed lenders/financiers; require transparent pricing and compliant collection practices.
- Unfair collection rules (multi-agency circulars) prohibit threats, public shaming, and unauthorized data disclosure.
Sectoral rules
- Banks, credit cards, and certain lenders are subject to Bangko Sentral and SEC circulars that, from time to time, cap or guide finance charges, fees, and collection practices. Settlements must respect any applicable sectoral caps and disclosure formats.

3) Building a valid interest-only settlement

A) Minimum terms to put in writing

Because interest exists only if written, an interest-only plan should be fully documented. Include:

Parties, facility, outstanding principal, and cut-off date for computation
Interest rate (per annum), basis (simple vs. compounded), day count (e.g., 360/365), reset mechanics
Payment schedule (monthly/quarterly interest-only), due dates, grace days, and modes of payment
Default events (missed interest, insolvency, misrepresentation) and remedies
Compounding rule (expressly state if no compounding or how/when it capitalizes)
Penalty charge (if any) and confirm it is alternative to, not in addition to, default interest—or clearly state if both apply (courts frown on double recovery)
Fees (restructuring, notarial, documentary stamp tax where applicable)
Security: status of mortgage/pledge; any amendment or additional collateral; updated annotations
Novation clause: clarify whether the agreement replaces prior covenants or supplements them
Reservation of rights and non-waiver
Governing law, venue, and dispute mode (mediation/arbitration)

B) When does it become novation?

Extinctive (old obligation is extinguished) if the new terms are incompatible (e.g., materially different cause/object) or if parties clearly intend a new contract.
Modificatory (same obligation, modified performance) if you simply push out principal amortization but keep the loan identity.
Practical effect: Extinctive novation can release sureties/guarantors unless they consent; modificatory typically does not—but if the change increases their risk, lack of consent can still release them under suretyship rules.

C) Security and foreclosure timing

An interest-only period often defers foreclosure, but only if the agreement expressly forbears from enforcing security while debtor is current on interest.
Keep taxes, insurance, and collateral maintenance covenants alive; non-payment can be an independent default.

4) Computation rules that matter in interest-only deals

Interest priority (Art. 1253): payments first extinguish interest, then principal, unless parties validly agree otherwise. If the schedule says “interest-only,” you are not paying down principal.
Compounding: only if clearly stipulated. If silent, assume simple interest; no interest on interest before judicial demand.
Penalties vs. interest
- Default interest compensates for delay; penalty is punitive/disciplinary. Courts may reduce either if unconscionable or duplicative.
- If both are charged, draft to avoid windfall (e.g., make penalty alternative, or cap the combined yield).
Rates may be judicially reduced
- Even without usury ceilings, courts reduce excessive rates (e.g., multi-percent monthly interest, stacked penalties, and automatic compounding). Keep to commercially reasonable levels and support with market context.
Legal interest overlay
- If the creditor sues, legal interest can start from demand (judicial or extrajudicial as pleaded) on the sum due; after finality of judgment, a single legal rate applies until paid.
Payment application across multiple debts (Art. 1252)
- Debtor may designate which debt a payment applies to; if not, creditor may apply, but interest-bearing debts and most onerous obligations are prioritized by law if neither designates. State the order in the settlement to avoid disputes.

5) Effects on prescription, taxes, and accounting

Prescription: a written acknowledgment or partial payment interrupts prescription (Art. 1155). An interest-only plan generally resets the clock from the last payment/acknowledgment.
Documentary Stamp Tax (DST): Original issue loans bear DST; a restructuring that increases principal or renews/extends tenor can trigger additional DST. Consult on specifics.
Withholding/Gross Receipts: Interest income of lenders may be subject to withholding or gross receipts taxes depending on lender type; for borrowers, interest may be deductible only if incurred in trade/business and properly substantiated.

6) Special contexts

A) Consumer/retail loans (non-bank lenders included)

Ensure TILA disclosures (finance charge, effective rate), clear fee tables, and plain-language terms.
Collection conduct must comply with unfair collection rules (no harassment, doxxing, or unauthorized contact lists).
Sectoral caps (e.g., for certain products like credit cards) may apply from time to time; check current circulars when drafting settlements.

B) Corporate and secured lending

Financial covenants (DSCR, leverage) may be waived or reset during interest-only periods—document whether waivers are one-time or rolling.
Intercreditor: If multiple creditors exist, interest-only on one facility may need consent under pari passu or negative pledge covenants.

C) Court-annexed or court-approved compromises

A compromise approved by the court has the effect of a final judgment; breach enables execution without a new trial.
Specify grace periods, notice-to-cure, and what amount becomes immediately due upon breach (e.g., only the missed coupons vs. entire debt accelerated).

7) Negotiating an interest-only plan: creditor & debtor playbook

For creditors

Obtain up-to-date financials and cash-flow model proving debtor can at least service interest.
Consider step-up rates, cash sweeps, or milestone-based conversion back to amortizing.
Preserve security and guarantor consents; register any amendments (e.g., real estate mortgage addenda).

For debtors

Push for simple interest, no compounding, and a hard cap on total charges.
Ask to net off penalty if default interest is already applied; avoid double hits.
Seek an interest holiday or capitalization only once at period end if necessary, with a ceiling.
Secure forbearance and standstill language to pause enforcement while compliant.

8) Typical pitfalls (and how to avoid them)

Oral agreements about rates or capitalization → unenforceable. Always write it down.
Ambiguous accrual dates → fights over legal interest. State exact dates and triggers.
Automatic compounding every 30 days without disclosure → ripe for judicial reduction.
Penalty + default interest + high fees → risk of being unconscionable or duplicative. Simplify and cap.
Security not aligned with new tenor → technical default despite paying interest. Amend and register security.
Ignoring surety/guarantor consent when risk increases → releases guarantor. Get written consent.

9) Sample term checklist (interest-only addendum)

Rate: __% p.a., simple, no compounding (unless expressly stated otherwise).
Accrual basis: Actual/360 (or chosen basis).
Interest period: Monthly, due every __ day of the month.
Late charge: __% per month (cap combined default yield at __% p.a.).
Compounding: None; capitalization only upon (date/event) at (rule).
Forbearance: No foreclosure or acceleration while current on interest and covenants A/B/C.
Security: REM/Chattel remains, amended to reflect new maturity (date); taxes/insurance kept current.
Covenants: Reporting, no additional liens, maintain insurance, pay taxes.
Events of default & cure: 5–15 day grace; notice by email + courier is valid.
Acceleration: Upon two consecutive misses or other material default.
Legal interest: If suit is filed, legal interest applies from extrajudicial demand (state date) or from filing, as applicable.
Novation: Modificatory only; no release of guarantors unless separate written consent.

10) Quick FAQ

Q: Can we agree that monthly interest unpaid will be added to principal? A: Yes, if expressly written. Courts may still strike down excessive results. If you capitalize, consider quarterly/one-time capitalization with a cap.

Q: We forgot to put the rate in writing. Can the lender still claim interest? A: Conventional interest—no. But legal interest can apply after demand/judgment on amounts due.

Q: Is an interest-only plan a novation that wipes prior defaults? A: Only if the document clearly says so or is incompatible with prior terms. Otherwise, it’s a forbearance; consider including an express waiver/clean-slate clause if that’s intended.

Q: Are penalties on top of default interest valid? A: They can be, but courts may reduce or treat them as alternative to prevent double recovery.

Q: Will paying interest only stop foreclosure? A: Only if the parties agreed to forbear enforcement while current on interest and covenants. Otherwise, the creditor may still accelerate/foreclose per contract.

11) Bottom line

Interest-only settlements are lawful and common, but they must be in writing, clear on rate/compounding, and fair. Structure them to:

Honor Civil Code priorities (interest before principal),
Avoid unconscionable total yields or duplicative charges,
Preserve (or properly amend) security and guarantees, and
Specify default triggers and legal-interest accrual.

If you share your scenario (type of lender, outstanding principal, proposed rate/fees, security, and whether you’re already in default), I can draft a tailored interest-only addendum and a cash-flow model to test affordability and legal risk.