In the Philippine legal landscape, the relationship between borrowers and lenders is governed by a mix of civil law, central bank regulations, and jurisprudence. Understanding the limits of interest rates and the accumulation of penalties is crucial for ensuring that credit remains a tool for growth rather than a cycle of perpetual debt.
1. The Principle of Autonomy and Its Limits
Under Article 1306 of the Civil Code, contracting parties may establish such stipulations, clauses, terms, and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy.
While the Philippines currently has no "ceiling" on interest rates (following the suspension of the Usury Law via CB Circular No. 905 in 1982), this autonomy is not absolute. The Supreme Court has consistently ruled that interest rates that are "unconscionable, iniquitous, or shocking to the senses" are void.
The "Unconscionable" Threshold
Courts generally scrutinize interest rates exceeding 24% per annum (2% per month). While not automatically illegal, rates reaching 36% to 66% per annum are frequently struck down or reduced to the prevailing legal rate (usually 6% per annum) if the lender cannot justify the high risk involved.
2. Types of Interest
It is vital to distinguish between the two types of interest recognized in Philippine law:
- Monetary Interest: The cost of hiring money; the compensation agreed upon for the use of the funds. This must be stipulated in writing to be demandable (Article 1956, Civil Code).
- Compensatory Interest: Also known as penalty or indemnity for damages. This is charged when the borrower defaults on the obligation.
3. The Compounding of Interest (Anatocism)
Compounding interest—or charging interest on interest—is generally prohibited unless specifically agreed upon by the parties in writing, or when judicial demand is made.
- Article 1959 (Civil Code): "Without prejudice to the provisions of Article 2212, interest due and unpaid shall not admit new interest, unless the parties at the time of the contract, or by subsequent agreement, shall have agreed that the accrued interest shall be added to the principal and itself bear interest."
- Article 2212 (Civil Code): Interest due shall earn legal interest from the time it is judicially demanded, although the obligation may be silent upon this point.
4. Penalty Clauses and Liquidated Damages
Lenders often include a "penalty clause" to discourage late payments. Under Article 1229 of the Civil Code, the judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with, or if the penalty is iniquitous or unconscionable.
| Feature | Legal Standard |
|---|---|
| Written Agreement | Must be explicitly stated in the Promissory Note or Loan Agreement. |
| Separation | Penalties are distinct from monetary interest; a loan can have both. |
| Judicial Review | Even if signed voluntarily, a court can slash a penalty if it finds it excessive (e.g., a 5% monthly penalty on top of 3% monthly interest). |
5. The Truth in Lending Act (R.A. 3765)
Transparency is a statutory requirement. Under the Truth in Lending Act, lenders are required to furnish each borrower, prior to the consummation of the transaction, a clear statement in writing setting forth:
- The cash price or deliverable amount;
- Down payments or trade-in allowances;
- Itemized charges (service charges, premiums, etc.);
- The total amount to be financed;
- The finance charge expressed in Philippine pesos; and
- The effective annual interest rate on the unpaid balance.
Consequence of Non-Compliance: Failure to disclose these details does not void the loan, but the lender cannot collect the finance charges and may be liable for fines or liquidated damages to the borrower.
6. BSP Circular No. 1133 (Ceilings on Small Loans)
While general commercial loans have no ceiling, the Bangko Sentral ng Pilipinas (BSP) recently imposed limits on specific types of credit to protect vulnerable consumers, particularly for "unsecured, short-term, small-value institutional loans" (often called Payday Loans or Online Lending Apps):
- Nominal Interest Rate: Capped at 6% per month (approx. 0.2% per day).
- Late Payment Penalties: Capped at 1% per month on the outstanding unpaid amount.
- Total Cost Cap: The total interest, fees, and charges cannot exceed 100% of the total amount borrowed, regardless of how long the loan remains unpaid.
7. Summary of Key Legal Principles
- No Written Stipulation, No Interest: If the contract doesn't mention a specific interest rate, the lender cannot charge monetary interest.
- The 6% Rule: If the contract stipulates "interest" but fails to specify the rate, the legal rate of 6% per annum (per BSP Circular No. 799) applies.
- Unconscionability is Void: If a rate is deemed "shocking," the court will void the rate itself, and the debt will be recalculated using the legal rate of 6% per annum.
- No Imprisonment for Debt: Under the Constitution, no person shall be imprisoned for debt. However, while you cannot go to jail for not paying a loan, you can face civil suits or criminal charges for issuing "bouncing checks" (B.P. 22) or estafa.