I. The Civil Code Framework: What “Interest on Loans” Means in Law

A. Loan under the Civil Code: Commodatum vs Mutuum

The New Civil Code (Republic Act No. 386) treats “loan” as a contract with two principal forms:

Commodatum – a loan of a non-consumable thing for use, with the obligation to return the same thing.
Mutuum (simple loan) – a loan of money or consumable goods, where ownership passes to the borrower, who must return an equivalent amount of the same kind and quality.

Interest in the everyday sense (payment for the use of money) is mainly a mutuum issue, because the borrower uses money that becomes his, and the lender is compensated either by agreement (conventional interest) or, in cases of default, by legal interest as damages.

B. Interest is Accessory and Not Presumed

In civil law, interest does not automatically attach to a loan. It is treated as an accessory obligation that must have a legal or contractual basis. This is why Philippine law is strict about when interest may be demanded.

II. Conventional Interest (Agreed Interest): The Core Civil Code Rule

A. The Writing Requirement (Civil Code, Art. 1956)

The most important Civil Code provision on loan interest is Article 1956:

No interest is due unless it is expressly stipulated in writing.

Practical consequences:

If the lender and borrower verbally agreed on interest but did not put it in writing, the lender cannot legally collect that conventional interest (even if both admit they talked about it).
The lender can still collect the principal (the amount loaned), because the loan itself remains valid.

What counts as “in writing”:

A promissory note, loan agreement, acknowledgment receipt, or any written instrument signed or otherwise attributable to the borrower that clearly shows the interest stipulation.
The stipulation should ideally state the rate, basis (per annum/per month), and when/how it accrues to avoid disputes.

B. If No Written Interest Stipulation Exists: What Can Still Be Collected?

If there is no written interest stipulation, the lender generally may collect:

Principal, and
Legal interest as damages only after default (discussed below), not “interest for the use of money” before default.

This is a key distinction: conventional interest (price of using money) requires a written stipulation; legal interest can arise as a form of indemnity for delay once the debtor is in default.

C. Voluntary Payment of Interest Without a Valid Stipulation (Civil Code, Art. 1960)

The Civil Code anticipates the scenario where a borrower pays interest even when none was validly stipulated. Article 1960 directs that the rules on solutio indebiti (payment by mistake) and natural obligations may apply depending on the circumstances.

In practice (as reflected in Philippine case law patterns):

Courts examine whether the payment was made by mistake, under compulsion, or voluntarily with knowledge.
Where interest is found not lawfully demandable, courts often credit payments against principal or order appropriate restitution depending on equities and proof.

III. Limits on Interest: Usury, Freedom of Contract, and Court Control

A. The Usury Law and the Modern Regime

The Philippines historically had statutory ceilings under the Usury Law (Act No. 2655, as amended). Over time, interest ceilings were effectively lifted/suspended through Central Bank issuances, and Philippine jurisprudence moved toward market-based rates subject to judicial review.

B. Unconscionable Interest and Judicial Reduction

Even in a regime without strict statutory ceilings, Philippine courts may strike down or reduce interest rates that are iniquitous, unconscionable, or shocking to the conscience.

How courts typically do it:

Reduce the interest to a reasonable level (often aligning with prevailing legal interest or a more moderate conventional rate), and/or
Treat excessive “interest + penalties” as effectively oppressive and reduce components under equitable principles.

Doctrinal anchors often invoked:

Civil Code provisions on human relations and abuse of rights (Arts. 19, 20, 21),
Control of penal clauses (Art. 1229), and
General equitable power to prevent unjust enrichment and oppression.

C. Escalation Clauses and Mutuality (Civil Code, Art. 1308 principle)

Loan contracts—especially bank loans—sometimes include escalation clauses allowing rate increases. Philippine doctrine requires that contracts must bind both parties and not leave performance to the will of one. In practice, escalation clauses are closely scrutinized and are typically expected to have:

Clear basis (e.g., reference rate), and
A mechanism that is not purely unilateral (often discussed as needing fairness and symmetry, including the idea of de-escalation where warranted).

IV. Kinds of Interest in Philippine Loan Practice (and Why Classification Matters)

To compute correctly, classify the interest being claimed:

A. Compensatory / Monetary Interest

This is the price for the use of money during the agreed loan term.

Requires express written stipulation (Art. 1956).
Computation depends primarily on the contract.

B. Moratory Interest (Interest as Damages for Delay)

This is interest imposed because the debtor is in default. It is grounded in the law on damages for delay in monetary obligations:

Civil Code, Art. 2209: If the obligation consists in payment of a sum of money and the debtor is in delay, damages are the payment of the interest agreed upon, and in the absence of stipulation, legal interest.

This can apply even when no conventional interest is validly stipulated—because it is not “interest for use,” but “interest as indemnity for delay.”

C. Penalty Interest / Liquidated Damages

Loan documents frequently impose a penalty rate upon default (e.g., “additional 2% per month penalty”).

This is often treated as a penal clause or liquidated damages.
Courts may reduce it if iniquitous (Civil Code, Art. 1229), especially when combined with high conventional interest.

D. Interest on Interest (Anatocism)

As a general rule, interest does not earn interest automatically. Philippine law limits compounding unless conditions are met.

A key Civil Code rule:

Civil Code, Art. 2212: Interest due shall itself earn legal interest from the time it is judicially demanded, even if the obligation is silent on this point.

Compounding may also be allowed if there is a clear written stipulation allowing capitalization of interest after it becomes due—subject again to scrutiny for unconscionability.

V. When Interest Starts Running: Default, Demand, and Maturity

A. Default (Delay) in Monetary Obligations (Civil Code, Arts. 1169 and 2209 interaction)

For legal interest as damages under Art. 2209, the debtor must be in delay.

General rule:

Delay begins upon demand (judicial or extrajudicial), unless demand is not necessary (e.g., when the obligation or circumstances make demand unnecessary, such as a loan with a fixed maturity date where performance is due on that date).

Practical guide:

If the loan has a due date: the borrower is typically considered in default upon failure to pay at maturity (often without need of further demand, depending on contract wording and context).
If the loan is payable on demand / no maturity date: default generally begins only after the lender demands payment.

B. Interest Before vs After Maturity

Common contractual structures:

Interest “until maturity” – compensatory interest stops at maturity; thereafter, you look for a default clause or apply legal interest as damages.
Interest “until fully paid” – conventional interest may continue post-maturity, subject to validity and unconscionability review.
Interest + penalty upon default – compensatory interest continues plus penalty interest accrues; this is frequently reduced if oppressive.

VI. Legal Interest in the Philippines: Rate and Judicial Rules (Civil Code + Jurisprudence)

The Civil Code provides the basis for legal interest (Arts. 2209 and 2212), but the rate and detailed framework have been refined by Philippine jurisprudence and Bangko Sentral issuances.

A. The Current Baseline: 6% Per Annum Legal Interest (Post–July 1, 2013)

Philippine doctrine generally recognizes 6% per annum as the legal interest rate beginning July 1, 2013, following the BSP’s reduction and the Supreme Court’s harmonizing rulings (commonly associated with Nacar v. Gallery Frames building on Eastern Shipping Lines).

B. Transitional Period: 12% Per Annum (Historically Applied Before July 1, 2013)

For periods before July 1, 2013, courts historically applied 12% per annum legal interest in cases involving loan or forbearance of money, following earlier Central Bank policy and Supreme Court doctrine.

C. The “Eastern Shipping / Nacar” Computation Structure (How Courts Compute in Judgments)

Philippine courts commonly apply a structured approach:

If the obligation is a loan or forbearance of money:
- If there is a valid stipulated interest rate: apply that rate as the monetary interest (subject to reduction if unconscionable).
- If there is no valid stipulated rate: apply legal interest as damages from default (demand/maturity) up to full satisfaction, with the historical 12%/6% transition depending on dates.
Once a money judgment becomes final and executory:
- The total adjudged amount typically earns legal interest (now 6% per annum) from finality until full payment, treating the unpaid judgment as a form of forbearance.

D. Liquidated vs Unliquidated Claims (Why It Matters)

Interest as damages depends on whether the amount is:

Liquidated/ascertainable (e.g., a fixed loan principal): interest can run from default.
Unliquidated (e.g., damages not yet quantified): interest may run only from the time the court determines the amount, depending on the nature of the claim and the judgment.

Loan principal is usually liquidated, so courts commonly award interest from default.

VII. Computation Mechanics: How to Compute Interest Correctly

Step 1: Identify the Principal Base

Interest is typically computed on the outstanding principal.
If there are partial payments, determine how they are applied (see Step 4).

Step 2: Identify the Applicable Interest Type and Rate

Conventional interest: contract rate, only if written (Art. 1956).
Moratory/legal interest: legal rate as damages for delay (Art. 2209) if no valid conventional stipulation or as a default rate.
Penalty interest: as stipulated, but may be reduced (Art. 1229).

Step 3: Determine the Time Period (Accrual Window)

Typical windows:

Release date → maturity date (compensatory period)
Maturity/default date → filing of case (still pre-judgment, often same rate depending on rules)
Judgment date → finality (depends on how the court frames interest)
Finality → full payment (post-judgment legal interest, typically 6%)

Step 4: Apply Payments Properly (Civil Code, Art. 1253)

Article 1253 provides a critical default rule:

If the debt produces interest, payment is not deemed applied to principal until interest is covered.

Meaning: unless the parties validly agree otherwise, partial payments are applied:

First to interest due, then
To principal.

This dramatically affects computation in long delays: the principal may stay high longer, producing higher interest, unless amortization rules or an agreed schedule allocates differently.

Step 5: Decide Whether Interest is Simple or Compound

Simple interest (most straightforward): interest does not itself earn interest.
Compound interest / capitalization: allowed only under specific legal bases (not automatic), and often litigated as to validity, consent, and unconscionability.

Step 6: Use the Correct Formula

Simple interest: [ \text{Interest} = P \times r \times t ] Where:

(P) = principal
(r) = rate per year (e.g., 6% = 0.06)
(t) = time in years (days/365 or months/12 depending on contract or court method)

Monthly rate conversions (common pitfall):

3% per month ≠ 3% per annum.
If a contract says “3% per month,” the nominal annual equivalent is 36% (before compounding effects).

VIII. Worked Examples (Philippine Legal-Style Scenarios)

Example 1: No Written Interest; Legal Interest as Damages After Default

Loan principal: ₱500,000
No written interest stipulation (Art. 1956 blocks conventional interest)
Due date: June 1, 2020
Not paid at maturity (default at maturity)
Fully paid: June 1, 2022
Applicable legal interest: 6% per annum (period is after 2013)

Compute:

Time: 2 years
Interest = 500,000 × 0.06 × 2 = ₱60,000
Total = ₱560,000

Key point: The lender cannot collect “interest for the use of money” during the term without a written stipulation, but can collect legal interest as damages for delay after default.

Example 2: Written 10% p.a. Interest Until Fully Paid; Late Payment

Principal: ₱1,000,000
Interest: 10% per annum, in writing, “until fully paid”
Released: Jan 1, 2021
Paid in full: Jan 1, 2024
No separate penalty clause

Compute (simple interest assumption):

3 years
Interest = 1,000,000 × 0.10 × 3 = ₱300,000
Total = ₱1,300,000

If the clause were only “10% p.a. until maturity,” then after maturity the computation could shift to moratory/legal interest unless another default-rate clause exists, depending on how the contract is drafted and interpreted.

Example 3: With Partial Payments and Article 1253 (Interest First)

Principal: ₱200,000
Written interest: 12% per annum
Term: 1 year
After 1 year, borrower pays ₱50,000 only, with no allocation agreement.

If interest for the year is:

Interest = 200,000 × 0.12 × 1 = ₱24,000

Under Art. 1253, the ₱50,000 payment applies:

₱24,000 to interest
Remaining ₱26,000 to principal

New principal balance = 200,000 − 26,000 = ₱174,000

This matters because subsequent interest is computed on the remaining principal (unless the contract uses different amortization mechanics).

Example 4: Judicial Demand and Interest on Interest (Art. 2212)

Unpaid interest has accrued and is due.
Lender files suit and judicially demands payment.
From that judicial demand, the interest due may itself earn legal interest (Art. 2212), producing an additional layer of legal interest—commonly called interest on interest—subject to how the court frames the award.

IX. Penalties, Attorney’s Fees, and the Court’s Power to Reduce

A. Penalty Clauses (Civil Code, Arts. 1226–1230)

Loan agreements often impose penalties upon default. Penalties serve as liquidated damages and may be cumulative with interest if the contract says so.

B. Reduction of Iniquitous Penalties (Civil Code, Art. 1229)

Even if agreed, courts may reduce penalties if:

Partly or irregularly complied with, or
The penalty is iniquitous or unconscionable.

In real loan litigation, the common battlefield is not just the principal—it is whether the combined burden of interest + penalty + other charges is enforceable as written.

X. Special Statutory Overlay (Still Relevant Even When the Topic is “Civil Code”)

While the Civil Code governs core obligations, loan interest disputes in the Philippines often intersect with statutes and regulations, particularly when the lender is a bank, financing company, or lending company:

Truth in Lending Act (RA 3765): requires meaningful disclosure of finance charges and effective cost of credit. Noncompliance can affect enforceability and remedies.
Financial Consumer Protection Act (RA 11765): strengthens consumer protection standards in financial products and services.
Regulatory rules may also cap or control interest/fees for specific products (e.g., certain consumer credit arrangements), depending on regulator and product type.

These do not replace the Civil Code’s contract and damages framework, but they influence validity, enforceability, and remedies.

XI. A Practical Checklist for Computing Interest in a Philippine Loan Dispute

Is the transaction a loan/forbearance of money?
Is there a written interest stipulation? (Art. 1956)
What kind of interest is claimed? (compensatory, moratory, penalty, judicial)
When did default begin? (maturity vs demand; Art. 1169 principles)
What rate applies for each period? (stipulated vs legal; consider 12%/6% transition by date)
How are partial payments applied? (Art. 1253 default)
Is compounding allowed by law/contract? (Art. 2212; written capitalization clauses)
Are the rates/penalties unconscionable? (possible judicial reduction)
If litigated, how is post-judgment interest computed? (typically 6% from finality until satisfaction)

XII. Key Takeaways

Conventional interest requires a written stipulation (Civil Code, Art. 1956). Without it, the lender generally cannot collect agreed “interest for use,” but can still recover principal and may recover legal interest as damages after default (Art. 2209).
Default timing controls when legal/moratory interest begins—often from maturity or demand, depending on the obligation’s terms and circumstances.
Payments generally go to interest first, then principal unless a valid allocation is agreed (Art. 1253), which materially affects balances and total interest.
Interest on interest is not automatic; it typically arises upon judicial demand (Art. 2212) or clear contractual capitalization, subject to validity and equity.
Even when interest is stipulated, courts may reduce unconscionable rates and penalties, especially when the total burden becomes oppressive.
For judicial awards, Philippine doctrine commonly applies structured rules (associated with Eastern Shipping and refined in Nacar) and recognizes the modern 6% per annum legal interest baseline for relevant periods after July 1, 2013.