Usury Laws on Compounded (Interest-on-Interest) in the Philippines

Snapshot

Usury ceilings under Act No. 2655 (the “Usury Law”) have been suspended since the early 1980s, so parties may generally agree on any interest rate—but courts still strike down unconscionable rates.
Compounded interest (interest earning interest, also called anatocism) is not automatic. It requires clear written stipulation, and even then may be policed for unconscionability.
Without a stipulation, unpaid interest does not earn further interest until judicial demand, at which point legal interest applies (as damages), not contractual compounding.
Several sectoral caps and conduct rules (e.g., for banks, credit cards, small-loan lenders) exist outside the Usury Law framework and may indirectly constrain compounding.

1) Statutory and Doctrinal Framework

A. The Usury Law and Its Suspension

Act No. 2655 (Usury Law) originally imposed ceilings on interest rates.
By Monetary Board circulars issued under central banking authority, those ceilings were suspended. The Usury Law was not repealed, but its rate caps stopped applying.
Practical effect: Freedom to stipulate interest rates subject to (i) the Civil Code, (ii) special statutes (consumer/banking), and (iii) judicial review for unconscionability or public policy.

B. Civil Code Baselines (when there is no valid stipulation)

Art. 1956: “No interest shall be due unless it has been expressly stipulated in writing.” Implication: Absent a written agreement, the principal does not bear interest.
Art. 1959 (read with Art. 2212): Interest due and unpaid does not earn interest—except interest may earn legal interest from the time of judicial demand (i.e., once sued, the interest component can itself bear legal interest as damages).
Arts. 1229, 2227: Courts may reduce penalty clauses that are iniquitous or unconscionable.
Freedom to contract (Art. 1306) is not absolute; stipulations contrary to law, morals, public order, or public policy are void.

C. Legal Interest (as Damages)

The “legal interest rate” (used for loans/forbearance and damages) is set by jurisprudence and monetary policy circulars.
This rate applies when:
1. No rate is stipulated, or
2. There is delay and damages are due, or
3. A court invalidates or reduces the contractual rate and substitutes legal interest.
Key point for compounding: legal interest is simple, not the contract’s private compounding scheme.

2) Compounded Interest: When Is It Enforceable?

A. Stipulation Is Essential

Courts require clear, written, and unequivocal language that (i) capitalizes interest at stated intervals (e.g., monthly/quarterly), and (ii) that the capitalized amount will thereafter earn interest at the same rate (or a specified rate).
Vague references to “prevailing rates,” “bank practice,” or “interest as may be charged” are not enough to prove compounding.

B. Judicial Limits: Unconscionability & Public Policy

Even with a clear compounding clause, courts may strike down the rate or the compounding if the effective burden is iniquitous. The Supreme Court has repeatedly voided exorbitant monthly rates and excessive penalty interest, reducing them to reasonable levels.
Penalty interest (for default) is distinct from compensatory interest (for use of money). Both are reviewable; double-layering high compensatory and high penalty rates—especially with compounding—invites judicial reduction.

C. Interest on Interest Without Stipulation

No: Unpaid interest does not earn additional interest by default.
Yes, but only as damages after suit: Once judicially demanded, the interest due may itself earn legal interest (simple) from the filing of the complaint—not the privately stipulated compounded rate.

3) Sector-Specific Rules That Indirectly Affect Compounding

Even though usury ceilings are suspended, regulators impose conduct rules and caps in specific markets. These do not “revive” the Usury Law but limit pricing and charges.

Banks and credit cards: The Bangko Sentral ng Pilipinas (BSP) issues circulars on pricing caps (e.g., maximum monthly rate on unpaid credit card balances) and fees. Compounding that defeats these caps or results in opaque/abusive charges can be sanctioned.
Lending and Financing Companies (SEC-supervised): The Lending Company Regulation Act (RA 9474) and Financing Company Act, with SEC rules, require clear disclosure of finance charges and prohibit unfair practices. Some short-term, small-amount loans have charge caps. Compounding that inflates the effective cost can be treated as abusive or misleading.
Pawnshops & micro-credit: BSP/SEC rules emphasize transparent disclosure and may set ceilings or formulaic limits on certain fees/charges. If compounding is employed, it must still respect disclosure and any applicable cap.

Practice tip: Because caps and fee limits change by circular, verify current BSP/SEC issuances before drafting or auditing compounding clauses.

4) Jurisprudential Themes to Remember

Freedom to stipulate ≠ license to oppress. Even after suspension of usury ceilings, the Court invalidates or reduces iniquitous rates (monthly double-digit rates, outsized penalties, or snowballing compounding).
Compounding must be crystal-clear. Ambiguity is resolved against the party imposing interest; unclear language is treated as simple interest only.
Penalty vs. compensatory interest are distinct and both subject to judicial moderation.
Substitution with legal interest: When a stipulated rate or compounding is voided, courts typically apply legal interest (simple) from the proper reckoning point.
Judicial demand triggers interest-on-interest (legal). Without stipulation, Art. 2212 allows legal (not contractual) interest on unpaid interest from filing of the case.

5) Drafting Compounding Clauses (Do’s & Don’ts)

Define the compounding interval (e.g., monthly) and specify that accrued interest is capitalized and thereafter earns interest at X% per annum (or the equivalent periodic rate).
Disclose the effective annual rate (EAR) and provide a worked example (see below).
Separate the regular rate and any default/penalty rate; state when each applies and avoid overlap.
Observe sectoral caps and disclosure rules (Truth in Lending Act; BSP/SEC circulars; Financial Consumer Protection Act).

Don’t

Hide compounding in fine print; avoid vague “prevailing bank rates” with no formula.
Stack a high regular rate, high penalty, compounding, and layered fees—courts will likely reduce.
Back-date capitalization or compound after acceleration on sums that already include future, unearned interest.

6) Computation Examples

A. Simple vs. Monthly Compounded Interest

Principal (P): ₱100,000
Nominal rate: 18% p.a.
Term: 1 year

Simple: Interest = ₱100,000 × 0.18 = ₱18,000; Amount Due = ₱118,000

Monthly compounding (nominal 18%/yr; 1.5%/mo): Amount Due = ₱100,000 × (1 + 0.18/12)¹² ≈ ₱100,000 × 1.1956 = ₱119,560 Effective annual rate (EAR) ≈ 19.56%

Note how a same nominal rate costs more with compounding. This is why EAR disclosure is important.

B. Capitalization Clause (illustrative language)

“Interest shall accrue on outstanding principal at 18% per annum, computed monthly at 1.5%, and capitalized at the end of each month, such that accrued interest is added to principal and thereafter bears interest at the same rate. Default interest of 3% per month applies only to amounts past due, from maturity or due date, whichever is applicable, without overlap with regular interest.”

This is an example, not a recommended rate. Always adapt to current caps/circulars and fairness tests.

7) Enforcement, Defenses, and Remedies

Lender’s burden: Prove a written stipulation authorizing compounding and the method used.
Borrower defenses:
- No written compounding clause → limit to simple interest.
- Unconscionability → ask the court to strike down/reduce rates/penalties/compounding.
- Truth-in-Lending defects → administrative and civil consequences; potential unenforceability of undisclosed charges.
- Computation errors → court-ordered re-computation; overpayments refundable or credited.
Court outcomes often include:
- Nullification of excessive rates/penalties,
- Substitution with legal interest (simple) from the proper date,
- Reduction of penalties under Arts. 1229/2227,
- Award of legal interest on unpaid interest from filing (Art. 2212).

8) Compliance Checklist (Philippine Context)

Written clause expressly authorizing compounding, with interval and formula.
Clear separation of regular vs. default/penalty interest; no double-charging.
Disclosure: Nominal rate, compounding frequency, EAR/APR, all fees; provide sample amortization.
Consistency with BSP/SEC circulars and any sectoral caps (e.g., credit cards, small-amount loans).
Reasonableness: Stress-test for unconscionability (effective burden at likely delinquency scenarios).
Collections language aligned with the Financial Consumer Protection Act (fair treatment; no abusive practices).
Record-keeping: ledgers showing capitalization events and running balances.
Litigation posture: be ready to recompute if the court moderates rates.

9) Frequently Asked Questions

Q1: Is compounding automatically allowed because usury ceilings are suspended? No. You still need an express written stipulation. Courts will invalidate unclear or oppressive compounding.

Q2: If there’s no compounding clause, can a lender still get interest on unpaid interest? **Yes, but only the court-imposed “legal interest” from the time the case is filed (Art. 2212)—not your private compounding.

Q3: Can I combine a high regular rate, penalty interest, and compounding? You can write it, but courts often reduce such setups as unconscionable, especially when the effective rate explodes.

Q4: What “legal interest” applies now? Courts apply the prevailing legal interest (simple) per the latest jurisprudence and monetary circulars. This is separate from any contractual compounding and can change over time.

Q5: Do credit-card or short-term cash-loan caps override my contract? Yes, sectoral caps and disclosure rules control. Contract terms that defeat regulatory caps or mislead borrowers are unenforceable and may be sanctioned.

Bottom Line

In the Philippines, compounded interest is enforceable only when expressly and clearly agreed in writing, consistent with consumer-protection statutes and fairness. Although usury ceilings are suspended, courts and regulators continue to police excessive effective rates, opaque calculations, and abusive penalty structures. Draft with clarity, transparency, and reasonableness, and verify current BSP/SEC issuances when dealing with sector-specific products.