THE LEGALITY OF A 15 % “PENALTY INTEREST” ON AMORTIZATION (Philippine Law and Jurisprudence)

This paper is for general information only and is not a substitute for personal legal advice. Where a controversy already exists, consult counsel immediately.

1. How “Penalty Interest” Fits Into a Loan Contract

| Conventional interest | Compensates the lender for the use of money. | | Penalty interest / penalty charge | Compensates the lender for the delay in payment (a penal clause under Art. 1226, Civil Code). |

They are conceptually distinct: one may stipulate either or both, and each may carry separate rates. When amortizations fall due and remain unpaid, the penalty rate “kicks in” and is computed in lieu of, or in addition to, the regular interest—depending on the wording of the contract.

2. Statutory Framework

2.1 The Usury Law (Act No. 2655) and the “lifting of ceilings”

Central Bank (CB) Circular 905 (22 Dec 1982) suspended all ceilings fixed by the Usury Law.
Since 1982 there is no statutory maximum for either conventional or penalty interest, but rates remain subject to the courts’ power to strike down stipulations that are “unconscionable, iniquitous, or contrary to morals or public policy” (Art. 1229 & Art. 1306, Civil Code; Art. 19, Civil Code—abuse of rights).

2.2 Civil Code provisions

Arts. 1956–1961 – Interest must be in writing to be demandable.
Art. 2209 – “Legal interest” (now 6 % p.a. per Nacar v. Gallery Frames, G.R. 189871, 13 Aug 2013) applies only when (a) the parties did not stipulate any rate, or (b) as interest on judgment.
Arts. 1229 & 2227 – Courts may reduce or nullify a penalty they deem unconscionable.

2.3 Bangko Sentral ng Pilipinas (BSP) regulations

BSP Circular 799 (30 Jun 2013) confirmed the 6 % legal interest rate for court judgments but does not impose a ceiling on contractual interest/penalties.
The Manual of Regulations for Banks (MORB) § X305.2 expects banks to disclose default charges separately and compute them “on the unpaid amount only.”

2.4 Sector-specific limits

Pag-IBIG Fund guidelines – 1/20 of 1 % per day (≈18 % p.a.) on defaulted housing loans.
DHSUD/HLURB Board Res. 922-13 (in-house real-estate financing) – penalty must not exceed 2 % per month (24 % p.a.).
Micro-finance (RA 9474) – No numeric ceiling, but borrowers must receive full cost disclosure.

2.5 Truth in Lending Act (RA 3765)

Lenders must disclose both the nominal rate and the effective interest rate, including penalties. Non-disclosure is an administrative offense and a strong equity argument against enforcement of onerous penalty clauses.

3. Supreme Court Treatment of High Penalty Rates

Case	Penalty stipulated	Supreme Court ruling
Medel v. CA, G.R. 131622, 27 Nov 1998	5.5 % per month (66 % p.a.)	Reduced to 12 % p.a.; “shocks the conscience.”
Castro v. Tan, G.R. 168940, 15 Feb 2008	5 % per mo. (60 % p.a.)	Reduced to 12 % p.a.
Spouses Abella v. Abella, G.R. 164258, 15 Aug 2012	7 % per mo. (84 % p.a.)	Reduced to 12 % p.a.
Security Bank v. Mercado, G.R. 192371, 26 Mar 2014	3 % per mo. (36 % p.a.)	Reduced to 12 % p.a.
Development Bank v. Astrodome Builders, G.R. 209551, 27 Jan 2021	5.5 % per mo.	Reduced to 12 % p.a.

Common threads:

Courts honour freedom to contract first.
They intervene only when the rate is grossly one-sided or the borrower shows unequal bargaining power.
The bench often resets the rate to 12 % p.a. (pre-2013 legal rate) or to 6 % p.a. (post-Nacar) depending on when the obligation fell due.

4. Is a 15 % Penalty Interest Valid?

4.1 When the 15 % is per annum

Generally upheld as reasonable, especially in commercial or unsecured lending.
Courts have repeatedly sustained rates between 18 % and 24 % p.a. where the parties are sophisticated and the obligation is not consumer-credit in disguise (e.g., PNB v. CA, G.R. 121790, 21 Jul 1999).

4.2 When the 15 % is per month (≈180 % p.a.)

Presumptively unconscionable. The Court has struck down even lower monthly penalties (see table above).
The lender must prove the rate is industry-standard and the borrower understood and freely accepted it. Even then, the Court’s typical remedy is to moderate the rate to the prevailing legal or commercially reasonable rate (usually 6 % or 12 % p.a.).

5. Drafting and Compliance Checklist

Put both the regular and penalty rates in bold, on the face of the contract.
State whether the penalty is in lieu of or in addition to regular interest. Courts resolve ambiguities in favour of the debtor.
Limit penalty charges to the amount in default, not the entire outstanding balance (except where an acceleration clause is triggered—and even then disclose it plainly).
Use a cap (e.g., “penalty shall not exceed the unpaid principal”) to forestall Article 1229 challenges.
Embed a “reduction clause.” Example: “If a court declares the penalty rate excessive, it shall be automatically reduced to the maximum rate the court may allow.”
Comply with BSP/SEC/DTI disclosure rules. Non-compliance can void the penalty clause or expose the lender to administrative sanctions.

6. Borrower & Lender Strategies in Litigation

Borrower

Plead unconscionability and offer jurisprudence.
Highlight information asymmetry (consumer loan, fine-print clause, no negotiation).
Ask the court to adopt the legal rate from Nacar.

Lender

Show that the borrower is a sophisticated business entity and that the rate is industry-customary.
Demonstrate clear, conspicuous disclosure and voluntary assent.
Cite freedom of contract and absence of a statutory ceiling.

7. Practical Benchmarks

Interest / Penalty Level	How Philippine courts usually treat it
≤ 12 % p.a.	Routinely upheld.
13 % – 24 % p.a.	Case-by-case; upheld if properly disclosed and commercially justified.
> 24 % p.a. but ≤ 3 % per mo. (36 % p.a.)	Increasingly suspect; often reduced.
> 3 % per mo.	Almost invariably reduced as unconscionable.

8. Key Take-aways

There is no statutory cap, but Article 1229 gives courts a safety valve.
15 % per annum is usually enforceable; 15 % per month is almost certainly not.
Proper drafting, disclosure, and documentation determine enforceability.
Even a valid clause may be reduced if circumstances show oppression or bad faith.

In short, a 15 % penalty interest passes legal muster only when it reflects a fair annual rate, is clearly disclosed, and is not imposed in a consumer-credit setting rife with informational imbalance. Otherwise, Philippine courts stand ready to pare it down to what equity—and public policy—deem just.