A legal-and-practical guide to how lenders compute interest, what borrowers should look for, and how Philippine law treats disclosures, enforceability, and “unconscionable” charges.

I. Why this topic matters in the Philippines

In the Philippine consumer and SME credit market, the same advertised “interest rate” can produce very different total costs depending on the computation method. Two borrowers may each be told they are paying “12% per year,” but one pays something close to 12% (actuarial/diminishing balance) while another effectively pays far more (flat/add-on), especially when repayment is by installment.

Because of this gap, disputes often arise over:

whether the lender properly disclosed the true cost of credit (Truth in Lending);
whether the contract language is clear enough to bind the borrower to a “flat” method;
whether interest, penalties, and fees are excessive/unconscionable under Civil Code and Supreme Court jurisprudence; and
how to compute pretermination/prepayment, rebates, and outstanding balances.

II. Core concepts: interest rate vs true cost of credit

A. Nominal rate, effective rate, and why they diverge

Nominal interest rate is the stated rate (e.g., 12% per annum).
Effective interest rate (EIR) / effective annual rate (EAR) reflects the actual cost after considering how interest is computed and when payments occur.
APR is commonly used to communicate total borrowing cost, often including certain finance charges, expressed annually.

A “flat” loan commonly quotes a low-looking nominal rate, but because interest is computed on the original principal even as the borrower repays, the effective rate increases.

B. Principal, outstanding balance, amortization

Principal: the amount borrowed.
Outstanding balance: remaining unpaid principal at any point in time.
Amortization schedule: table showing how each payment is split into interest and principal and how the balance declines.

III. What “Schedular” and “Flat” usually mean in PH lending practice

Terminology varies across banks, financing companies, cooperatives, and fintech lenders. In Philippine usage:

A. “Schedular” (schedule-based / actuarial / diminishing balance) interest

Often refers to a method where interest is computed on the outstanding balance per period, consistent with an amortization schedule.

Key feature: as the principal balance declines, the interest portion generally declines, and the borrower’s payments increasingly go to principal.

This is also commonly described as:

diminishing balance
reducing balance
actuarial method
amortized / annuity method (when payments are equal)

B. “Flat” (add-on) interest

Under a flat method, interest is computed on the original principal for the entire term, typically:

Total interest = Principal × Flat Rate × Time Total payable = Principal + Total interest Installment = Total payable ÷ number of installments

Key feature: the borrower pays interest as if the lender’s money was outstanding at the full principal for the whole term—even though the borrower is steadily paying it down.

Flat interest is common in some:

financing company products,
short-term installment loans,
certain dealer-assisted auto/motorcycle financing structures,
some cooperative and micro-lending designs (though not universal).

IV. How the computations work (with Philippine-style examples)

Assume a ₱100,000 loan payable monthly for 12 months.

A. Flat (add-on) 12% per year, 12 months

Compute total interest

₱100,000 × 12% × 1 year = ₱12,000

Total payable

₱100,000 + ₱12,000 = ₱112,000

Monthly installment

₱112,000 ÷ 12 = ₱9,333.33

What’s the catch? Although the quoted rate is “12%,” the borrower’s actual cost is higher because the borrower’s average outstanding balance across the year is much less than ₱100,000 (it declines every month). With level monthly payments, this structure typically produces an effective annual rate far above 12%.

B. Schedular / diminishing balance 12% per year (1% per month), 12 months, equal installments

Using standard amortization (annuity) math:

Monthly rate: 1%
Payment is computed so the balance reaches zero at month 12.

Resulting payment is approximately ₱8,884.88 per month. Total paid is about ₱106,618.55.

Comparison snapshot

Flat 12%: pay ₱112,000 total
Diminishing 12%: pay ~₱106,618.55 total Same “12%” label, materially different total cost.

V. Practical indicators: how to tell which method is being used

A. Contract language clues for flat/add-on

Look for phrases like:

“add-on interest,” “flat rate,” “discounted interest,”
“interest computed on the original principal,”
“total interest shall be computed upfront,”
“finance charge is fixed for the term.”

B. Contract language clues for schedular/diminishing balance

Look for:

“interest computed on outstanding balance,”
“reducing balance,” “diminishing balance,” “actuarial,”
a detailed amortization schedule showing declining interest portions.

C. Red flags in documents and sales talk

A very low monthly percentage (e.g., “2% per month flat”) pitched as if it were simply equivalent to a 24% annual diminishing rate.
No clear disclosure of EIR/APR or finance charge breakdown.
Bundled fees described as “processing” or “service” but functionally operating as interest.

VI. Philippine legal framework affecting loan interest computations

A. Civil Code rules that shape enforceability

Stipulated interest must be in writing (Civil Code, Art. 1956). If interest is not properly stipulated in writing, collection of interest can be challenged (though principal remains due).
Interest on damages for delay and legal interest concepts (Civil Code, Art. 2209, plus jurisprudence). When an obligation is breached and money is due, courts impose legal interest depending on the nature of the obligation and the period.
Unconscionable interest and equitable reduction (jurisprudence). Even with CB Circular No. 905 (lifting usury ceilings), Philippine courts have repeatedly ruled that excessive, iniquitous, or unconscionable interest rates may be reduced.

B. Usury: “lifted ceilings” is not “anything goes”

CB Circular No. 905 (1982) effectively removed statutory interest ceilings under the Usury Law.
But the Supreme Court has consistently held that courts may intervene when interest/penalties are shocking to the conscience or clearly oppressive.

Landmark cases commonly cited in this area include:

Medel v. Court of Appeals (interest found iniquitous; reduced),
Eastern Shipping Lines v. Court of Appeals (legal interest framework; later refined),
Nacar v. Gallery Frames (updated legal interest treatment; recognizes the shift to 6% legal interest from July 1, 2013 under BSP/Monetary Board issuance).

C. Truth in Lending Act (RA 3765): disclosure is the heart of the regime

RA 3765’s policy is to ensure borrowers can compare credit terms through meaningful disclosure, typically including:

finance charge,
amount financed,
total of payments,
and the effective rate/annual percentage context (depending on implementing rules).

Practical legal takeaway: Even if “flat interest” is not automatically illegal, failure to clearly disclose the method and true cost can expose lenders to statutory penalties and can strengthen borrower defenses in disputes over charges.

D. Sectoral regulation and who supervises what

Different regulators apply depending on the lender type:

Banks and BSP-supervised institutions: subject to BSP regulations on consumer protection, disclosure, and financial products governance.
Lending companies and financing companies: typically regulated by the SEC under their respective enabling laws and SEC rules.
Cooperatives: regulated primarily by the CDA, though certain cooperative financial services may interact with other frameworks depending on structure.
Pawnshops: historically regulated under special laws and BSP oversight frameworks in many contexts.

Why it matters: regulatory rules affect required disclosures, complaint handling, and permissible fee structures.

VII. Fees, penalties, and “hidden interest” issues

In Philippine disputes, borrowers often challenge not just the nominal interest rate but the overall charge load, including:

processing/service fees,
documentary stamp or administrative charges (and who bears them),
late payment penalties,
compounded penalty + interest structures,
collection fees/attorney’s fees.

A. When fees behave like interest

A fee may be labeled “processing,” but if it is:

mandatory,
tied to the granting of credit,
and effectively increases the lender’s yield,

it can be treated as part of the finance charge for disclosure and fairness analysis.

B. Penalty stacking and compounding

Courts tend to look skeptically at structures like:

high interest + high penalty interest + monthly compounding + fixed collection fees, especially when the borrower is a consumer or the borrower’s bargaining power is clearly weaker.

VIII. Prepayment, rebates, and early termination: flat vs schedular effects

A. Schedular/diminishing balance loans

Prepaying early generally reduces future interest because interest is computed on the outstanding balance. A proper payoff quote typically includes:

remaining principal,
accrued interest up to payoff date,
and any contractually allowed prepayment fee (if valid and properly disclosed).

B. Flat/add-on loans

Prepayment disputes are more common because:

the interest was computed upfront, and
the lender may claim the full “add-on” interest is still due.

Legally and practically, outcomes depend heavily on:

the specific contract wording,
disclosures given at origination,
any rebate clause (e.g., unearned interest rebate),
and fairness/unconscionability considerations.

Borrower best practice: demand a written payoff computation showing what portion is principal vs “unearned” charges and the legal basis for any retained finance charge.

IX. Litigation and enforcement angles in the Philippine context

A. Common borrower defenses/claims

lack of written stipulation for interest (Art. 1956),
ambiguous contract terms (construed against the drafter in many contexts),
Truth in Lending disclosure deficiencies,
unconscionable interest/penalty (equitable reduction),
misrepresentation / deceptive sales practice (consumer protection principles, when applicable).

B. Common lender positions

freedom to contract post-CB Circular 905,
borrower consent evidenced by signed promissory note/disclosure statement,
loan proceeds actually received and enjoyed,
industry practice for add-on/flat pricing (not a full defense if disclosure is inadequate, but often raised).

C. Remedies courts often apply

Depending on facts, courts may:

enforce principal and reasonable interest,
reduce interest/penalties to equitable levels,
disallow certain fees for lack of proof or disclosure,
impose legal interest on adjudged sums in line with jurisprudential rules.

X. Compliance and drafting guidance (for lenders and practitioners)

A. Minimum documentation checklist (practical)

Promissory note / loan agreement clearly stating:
- computation method (flat vs outstanding balance),
- frequency, compounding (if any),
- fees and when imposed,
- default interest/penalties.
A clear disclosure statement consistent with Truth in Lending policy:
- finance charge breakdown,
- total of payments,
- EIR/APR or equivalent disclosure required by the lender’s regulator.
Amortization schedule (for schedular loans) or a transparent payment table (for flat loans).
Prepayment clause: how rebates/unearned charges are treated.
Clear definitions: “interest,” “penalty,” “service fee,” “processing fee,” “collection cost.”

B. Drafting tips that prevent disputes

Put the method in a single bold sentence: “Interest shall be computed on the outstanding principal balance (diminishing balance)” or “Interest is computed upfront on the original principal (flat/add-on) and is included in the installment amounts.”
If flat: disclose an effective rate illustration or equivalent disclosure so borrowers understand the real cost.
Avoid penalty stacking that produces extreme effective charges.

XI. Consumer guide: how to compute and compare offers quickly

A. Ask for these numbers in writing

Amount financed (cash received or net proceeds)
Total of payments
All mandatory fees
Payment schedule (amount and due dates)
Computation method (flat vs outstanding)

B. A fast comparison approach

Even without advanced math, borrowers can:

compare total payable across offers for the same principal and term;
ask lenders to state the effective annual rate based on the actual installment schedule; and
insist on a sample amortization schedule or payment table.

C. A simple sanity test

If two loans both claim “12% per year” but one has much higher monthly installments or total payable, it is likely:

flat/add-on,
or loaded with finance charges/fees,
or both.

XII. Key takeaways

Schedular (outstanding balance) interest generally tracks intuitive fairness: interest declines as the balance declines.
Flat (add-on) interest often produces a much higher effective rate than the headline rate—especially for installment loans.
In the Philippines, interest ceilings may be lifted, but unconscionable interest and penalty structures remain vulnerable to judicial reduction.
Disclosure is central: under the Truth in Lending policy framework, lenders should clearly communicate the method and the true cost of credit; borrowers should demand this in writing.
Many disputes are avoidable with clear drafting, transparent amortization/payment tables, and fair prepayment/rebate clauses.

If you want, paste a sample loan offer (principal, term, installment, stated rate, fees), and the computation can be reverse-engineered to estimate whether it’s flat or schedular and what the approximate effective annual rate is—purely from the numbers.