1) Why the issue matters

Loan disputes in the Philippines often turn less on whether money was borrowed and more on how much the borrower must pay on top of the principal: interest, default interest, penalties, service fees, collection charges, attorney’s fees, and other “finance charges.” While Philippine law generally respects freedom of contract, courts have repeatedly held that loan charges can be moderated or struck down when they become “unconscionable”—so excessive that enforcement would be inequitable.

This article explains the governing rules, the doctrines used by courts, and how unconscionability is assessed and remedied in actual cases.

General note: This is a legal-information article written for Philippine context and is not legal advice.

2) Key concepts and vocabulary

a) “Loan” in Philippine civil law (mutuum)

Most interest disputes involve a simple loan (mutuum): ownership of money passes to the borrower, who must return the equivalent amount at maturity. A promissory note typically documents the obligation.

b) Interest vs. penalties vs. fees

Loan charges commonly appear in layers:

Compensatory (ordinary) interest – price for the use of money during the loan term.
Moratory interest – interest imposed because of delay/default (sometimes called default interest).
Penalty charges / liquidated damages – a stipulated “penalty” for breach or delay, conceptually distinct from interest but often computed similarly (e.g., “x% per month on unpaid balance”).
Service fees / processing fees / “admin” fees / collection fees – charges sometimes framed as non-interest but treated by law/regulators as part of the overall finance charge depending on structure.
Attorney’s fees – sometimes fixed at 10%–25% of the amount due in promissory notes; in court, recoverability is constrained by the Civil Code and jurisprudence.

Why labels don’t fully control: Courts look at substance over form. Calling a charge a “service fee” or “liquidated damages” does not automatically save it if the total burden becomes oppressive.

3) The basic Civil Code rules on interest

a) Interest must be in writing (Civil Code, Art. 1956)

A foundational rule: No interest is due unless it has been expressly stipulated in writing. Implications:

If a loan exists but the interest agreement is not in writing, stipulated interest is not collectible as such.
Even without stipulated interest, the borrower who fails to pay on time may still be liable for damages for delay, where legal interest can apply under rules on obligations and damages (discussed below).

b) Interest on interest (anatocism) is restricted (Civil Code, Art. 1959; and related damages provisions)

As a general principle, unpaid interest does not itself earn interest unless certain legal conditions are met (commonly: a written agreement after it becomes due, and/or judicial demand, depending on the nature of the claim and how it is pleaded).

This matters because “compounding” can explosively increase the debt and can contribute to a finding of unconscionability.

c) If interest was paid without a valid stipulation (Civil Code, Art. 1960)

Payments of interest when no valid interest obligation existed may trigger rules on solutio indebiti (undue payment) or be treated as applying to principal depending on the circumstances and equities.

4) Usury vs. unconscionability: the post-ceiling landscape

a) The Usury Law and the removal of fixed ceilings

Historically, the Usury Law imposed interest ceilings. Over time, interest rate ceilings were effectively lifted through Central Bank/Monetary Board action (notably through policy circulars), enabling parties to stipulate rates freely in many private credit transactions.

But the lifting of ceilings did not create a free-for-all. Even in the absence of a statutory numeric cap, Philippine courts continue to police extreme loan charges through equitable doctrines and specific Civil Code provisions.

b) The modern control mechanism: “unconscionable” interest and charges

Philippine jurisprudence recognizes that interest rates and related charges may be voided or reduced when unconscionable, even if signed and written, because:

Freedom of contract is limited by law, morals, good customs, public order, and public policy (Civil Code, Art. 1306).
Courts are courts of law and equity; they will not enforce terms that are shocking, iniquitous, or grossly excessive, especially where bargaining power is unequal.

5) What counts as “unconscionable” in practice

a) No single bright-line number

A crucial point: Philippine courts generally do not apply a universal numeric threshold (e.g., “anything above 24% per annum is illegal”). Instead, they look at:

the rate itself (monthly vs annualized),
whether it is ordinary interest or default interest,
whether there are additional penalties and fees layered on top,
the total effective burden,
the circumstances of the parties and the transaction.

That said, Supreme Court decisions have repeatedly found very high monthly rates (and combinations of monthly interest plus monthly penalties) to be unconscionable, especially when they can rapidly exceed the principal.

b) Factors courts commonly consider

While phrasing varies across cases, analysis commonly revolves around:

Magnitude of the rate and total charges Rates expressed “per month” can conceal extreme annual equivalents (e.g., 5%/month ≈ 60%/year, excluding compounding and penalties).
Stacking and duplication Courts react strongly to piled-on charges: ordinary interest + default interest + penalty + fixed collection fee + attorney’s fees—particularly when computed on the same base and running concurrently.
Adhesion and inequality of bargaining power Many promissory notes are form contracts. Adhesion alone does not invalidate, but it can support a finding that harsh terms are oppressive.
Purpose and risk A higher rate may be argued as risk pricing, but courts still ask whether the result is grossly disproportionate.
Conduct and fairness Harsh collection behavior is not the same as unconscionable interest, but oppressive practices can influence how a court views the equities and the reasonableness of charges.
Public policy considerations Courts avoid outcomes where the debt becomes a perpetual, ballooning obligation.

c) Practical red flags that often trigger judicial reduction

Double-digit monthly interest (and even lower monthly rates when paired with equally heavy penalties)
Penalty interest equal to or higher than ordinary interest
Simultaneous default interest and penalty both running monthly
Compounding that rapidly surpasses the principal
Attorney’s fees fixed as a large percentage without proof of reasonableness (especially when treated as automatic)

6) The court’s toolbox: how Philippine law reduces excessive loan charges

When a court finds loan charges excessive, outcomes typically fall into one or more of these approaches:

a) Declare the interest stipulation void (in whole or in part) and apply legal interest

A frequent remedy is:

Principal remains payable (the loan itself is not erased),
the excessive interest clause is voided or disregarded, and
the court imposes legal interest (as damages for delay or as appropriate under the nature of the obligation and applicable jurisprudential guidelines).

b) Reduce (“temper”) the rate to a reasonable level

Sometimes courts do not wipe the clause entirely but reduce the stipulated rate to what they deem equitable under the circumstances.

Historically, decisions often used benchmark legal rates prevailing at the time as a reference point. A major modern benchmark is 6% per annum legal interest in many contexts (reflecting the post-2013 legal-interest regime for judgments and forbearance of money), but courts may still tailor the remedy depending on when the obligation arose and the controlling doctrine for that period.

c) Reduce penalties under Civil Code Article 1229

If the promissory note includes a penalty clause (common in default), Article 1229 allows courts to equitably reduce the penalty if:

there has been partial/irregular performance, or
the penalty is iniquitous or unconscionable.

This is one of the most direct statutory bases for cutting down default penalties even when written and agreed.

d) Scrutinize attorney’s fees (Civil Code Article 2208 and jurisprudence)

Even if a promissory note says attorney’s fees are, say, 25% of the amount due, courts commonly treat attorney’s fees as:

not automatic, and
subject to reasonableness and the rule that attorney’s fees must be justified under Article 2208 and supported by factual findings.

e) Recompute the obligation and apply payments properly

When terms are voided or reduced, courts typically:

recompute the debt using the moderated rates,
apply prior payments first according to the governing rules and equities (often to principal when interest claims are invalid),
and prevent “interest on interest” except where legally justified.

7) A crucial distinction: interest as a price vs. interest as damages

a) Stipulated interest (price of money)

This is collectible only if expressly stipulated in writing and not void as unconscionable.

b) Legal interest for delay (damages)

Even when stipulated interest fails (e.g., not in writing, or struck down), once the borrower is in delay (typically after demand or upon maturity depending on terms), courts may impose legal interest as damages under Civil Code principles on breach of monetary obligations.

c) Interest in judgments: the Eastern Shipping / Nacar framework

Philippine jurisprudence developed structured rules on when and how to apply interest in judgments involving money claims and forbearance. Key ideas include:

distinguishing between loan/forbearance and damages,
applying interest from appropriate points (e.g., demand, filing of case, finality of judgment),
and applying post-judgment interest to the adjudged amount until satisfaction.

The most cited modern framework reflects the shift to 6% per annum as the standard legal interest in many contexts after policy changes effective July 2013. The exact application can depend on the timing of the obligation and the judgment.

8) How “other charges” can become unconscionable even if the interest rate looks moderate

A lender may advertise an interest rate that seems ordinary but impose heavy add-ons:

Processing fee deducted upfront (“discounting”), effectively increasing the true rate.
Monthly “service fee” that functions like interest.
Late fees + penalty interest both applied monthly.
Collection fee as a fixed percentage on default.
Insurance premiums or “membership fees” tied to the loan.

Courts and regulators often focus on the effective cost of credit. Even if each charge is described differently, the overall package can be treated as oppressive.

9) Regulatory overlay: disclosures and supervised lenders

Unconscionability is a judicial doctrine, but the regulated credit environment adds rules that influence enforceability.

a) Truth in Lending Act (RA 3765)

RA 3765 requires creditors covered by the law to make meaningful disclosure of the finance charges and the true cost of credit. While the statute is primarily about disclosure (not setting a universal cap), failure to comply can:

expose the creditor to statutory consequences, and
support arguments that charges are unfair or that the borrower did not give informed consent.

b) Lending companies, financing companies, and online lending platforms

Lending/financing entities are subject to oversight (commonly by the SEC for lending/financing companies, and by the BSP for banks and certain supervised institutions). Regulatory issuances can:

require standardized disclosure,
regulate collection practices,
and in some periods or sectors, impose specific limits or guardrails on interest and fees.

Because these rules can vary across entity type and time, enforceability may turn on whether the lender was:

a bank or quasi-bank,
a financing/lending company,
a cooperative,
a pawnshop,
an individual lender, and what regulatory circulars applied at the time of contracting.

c) Consumer protection principles (Consumer Act; unfair practices)

Where loan marketing or collection involves deception, harassment, or abusive terms, consumer-protection concepts and general civil-law principles on damages may come into play alongside unconscionability.

10) Litigation dynamics: how unconscionable interest issues are raised and decided

a) Where the issue arises

Common scenarios:

Collection suit by the lender (civil case for sum of money; foreclosure deficiency; enforcement of promissory note).
Borrower’s action to annul/reform terms or recover excess payments.
Defense in collection: borrower admits principal but challenges the interest/penalty as void or reducible.

b) Evidence that matters

The written instrument (promissory note/loan agreement).
Payment history and statements of account.
Computations showing the effective annualized rate and the impact of penalties/fees.
Proof of demand (letters, notices) and dates (important for interest accrual).
Proof relevant to attorney’s fees and costs.

c) Pleading and computation issues

Courts often confront:

ambiguous clauses (“x% monthly on outstanding balance” — does it compound?),
acceleration clauses (making the entire balance due upon default),
overlapping default provisions (moratory interest + penalty),
and mathematical errors in lender computations.

A persuasive unconscionability argument is usually quantified: it shows how the debt grows relative to the principal and why the growth is inequitable.

11) Worked example: how charges can become oppressive

Principal: ₱100,000 Term: 12 months Ordinary interest: 5% per month (simple) Default penalty: additional 5% per month on unpaid principal (runs upon default)

If the borrower fails to pay for 12 months and both charges run:

Ordinary interest: 5% × 12 × ₱100,000 = ₱60,000
Penalty: 5% × 12 × ₱100,000 = ₱60,000
Total add-ons (excluding any fees): ₱120,000
Total claimed: ₱220,000 on a ₱100,000 loan, in one year—before compounding, attorney’s fees, or collection charges.

If compounding is applied or if charges are computed on an “unpaid balance” that includes prior charges, the figure can climb further.

By contrast, if a court strikes the stipulation and applies 6% per annum legal interest as damages for delay (depending on the applicable doctrine and timing), one year’s interest is ₱6,000, not ₱120,000—illustrating why courts intervene when terms are grossly excessive.

12) What courts typically do after finding unconscionability

Outcomes commonly include:

Principal is enforced as the core obligation.
Excess interest/penalty provisions are reduced or annulled.
The borrower is ordered to pay:
- principal, plus
- moderated interest (often legal interest as damages, applied from a legally significant date such as demand or filing), and sometimes
- tempered attorney’s fees only if justified.
Payments already made are re-applied consistently with the moderated computation (often preventing the lender from keeping “excess interest” if the clause is void).

13) Practical drafting and compliance notes (why lenders lose these issues)

Loan documents that are most vulnerable tend to have:

high monthly rates without justification,
stacked default charges,
vague bases for computation (“outstanding balance” without defining whether it includes fees/interest),
automatic attorney’s fees at high percentages,
compounding mechanisms not clearly disclosed,
and disclosures that don’t reflect the true cost of credit.

From an enforceability standpoint, the most defensible loan pricing is:

clear,
transparently disclosed,
internally consistent (no double counting),
and not so harsh that it predictably overwhelms the principal in a short time.

14) Borrower-side issue spotting (what to look for in a promissory note)

Common clauses that deserve close scrutiny:

Interest “per month” that is high when annualized.
“Penalty” that mirrors the interest rate and runs simultaneously.
“Interest on interest” or compounding language.
Acceleration clause + default interest + penalty + collection fee + attorney’s fees all triggered at once.
Ambiguous definitions of “balance” or “amount due.”
Upfront deductions that increase the effective rate.
Disclosures that do not match the amounts actually charged.

15) Bottom line doctrine

In the Philippines, the absence of a universal statutory interest ceiling in many transactions does not mean any written rate is enforceable. Courts can and do intervene when:

the interest rate is grossly excessive, or
the total package of charges (interest + penalties + fees) becomes oppressive, or
enforcement would be inequitable and contrary to public policy.

The typical judicial response is not to cancel the debt, but to enforce the principal while moderating or voiding unconscionable charges, often substituting legal interest and reducing penalties under Civil Code Article 1229, with attorney’s fees awarded only when justified and reasonable.