Excessive Interest Rates on Short-Term Loans in the Philippines: A Comprehensive Legal Overview

Disclaimer: This article is for educational and informational purposes only. It does not constitute legal advice. For specific questions about your situation, please consult a qualified legal professional.

1. Introduction

Short-term loans—ranging from payday loans, small personal loans, salary loans, or “5-6” informal borrowings—are widely accessible in the Philippines. They typically feature quick processing times but often come with high interest rates. When these rates become excessive or unconscionable, borrowers may be forced into a cycle of debt. This article provides an in-depth discussion of the legal landscape governing interest rates on short-term loans, highlighting legislative measures, relevant jurisprudence, and regulatory frameworks in the Philippines.

2. Historical Background: Usury Law

2.1 The Usury Law (Act No. 2655)

Enacted in 1916, the Usury Law initially imposed ceilings on interest rates to protect borrowers from predatory lending.
Over the years, the ceilings proved too rigid for an evolving economy, prompting amendments and adjustments.

2.2 Suspension by Central Bank Circular No. 905

In 1982, Central Bank Circular No. 905 effectively suspended the Usury Law’s fixed ceilings.
As a result, there is no longer a strict statutory cap on the interest rate that parties can agree upon, as long as it is within the boundaries of law, public policy, and morals.
Nevertheless, courts have retained the power to reduce or strike down unconscionable interest rates.

3. Legal Framework Governing Interest Rates

3.1 Civil Code Provisions

Article 1306 of the Civil Code recognizes the parties’ freedom to stipulate terms in a contract, including interest rates, provided they are not contrary to law, morals, or public policy.
Article 2209 of the Civil Code sets the legal interest rate for indemnities in the absence of any stipulation. Historically, this was pegged at 12% per annum until the Supreme Court, interpreting subsequent Bangko Sentral ng Pilipinas (BSP) circulars, adjusted the legal interest rate to 6% in certain instances (e.g., judgment awards).

3.2 Bangko Sentral ng Pilipinas (BSP) Regulations

The BSP issues circulars and regulations that, while primarily guiding banks and financial institutions, also influence the general view on permissible rates.
BSP Circular No. 799 (2013) clarified that the rate of 6% per annum would apply to judgments involving loans and other forbearances of money when no rate is stipulated. However, this circular does not set a hard cap on contractual interest.

3.3 Lending Company Regulation Act (Republic Act No. 9474)

This law governs the formation and operation of lending companies in the Philippines and requires them to be registered with the Securities and Exchange Commission (SEC).
It mandates transparency and disclosure of loan terms, including interest rates, penalties, and fees. However, it does not impose a fixed maximum interest rate; it simply requires that interest and charges be clearly disclosed and not be “unconscionable.”

3.4 Microfinance NGOs Act (Republic Act No. 10693)

Encourages microfinance for poverty alleviation but similarly focuses on transparency and consumer protection, rather than imposing specific interest caps.

3.5 Other Consumer Protection Laws

The Financial Consumer Protection Act (FCPA) (Republic Act No. 11765) provides a broad framework for financial consumer protection, enhancing regulators’ authority to address abusive practices. Under this law, BSP, SEC, and other financial regulators can issue rules penalizing unfair and abusive lending practices, including potentially excessive interest rates.

4. The Concept of “Unconscionable” Interest

Even though the strict caps were removed, courts may annul or reduce interest rates they deem unconscionable or exorbitant. In numerous Supreme Court decisions:

Courts look at the totality of the circumstances—including the relative bargaining power of the parties, the nature of the loan, and economic realities—to determine if the agreed interest rate is grossly excessive.
While there is no fixed numerical benchmark, Philippine jurisprudence has struck down rates of 3% to 6% per month (36% to 72% per annum) in specific contexts if found unreasonably burdensome. Conversely, some loans with monthly interest rates in that range have been upheld when justified by business realities or other factors.

4.1 Common Supreme Court Findings

45% to 60% per annum has frequently been found unconscionable when the borrower is a low-income earner and had little to no negotiating power.
Courts often reduce such interest rates to a more “equitable” figure—commonly around 12% or, in certain newer rulings, 6% per annum from the date of default (aligned with current legal interest guidelines).
Interest on interest (i.e., compounded interest) is also scrutinized. If interest charges pile up unreasonably or if penalty charges are unjustifiably high, courts may declare them void or reduce them to a more reasonable rate.

5. Typical Scenarios and Key Legal Concerns

Payday or Salary Loans
- Often arranged through a borrower’s employer or directly through micro-lending companies.
- They can carry high interest or fees (e.g., 5% to 10% for a short period of two weeks or a month). When annualized, these rates can be extremely high.
“5-6” Lending
- An informal lending practice where lenders might charge 20% (or more) interest per month.
- Common in local communities and among small-scale entrepreneurs who lack access to formal credit.
- While pervasive, 5-6 loans often operate outside of formal registration and risk being characterized as predatory lending.
Online Lending Apps
- Rapid growth of fintech and online lending platforms has led to new concerns over data privacy, harassment, and excessive rates or penalties.
- The SEC and BSP have issued warnings and regulations requiring proper disclosure of rates and prohibition of abusive collection practices.
Small Business or Microfinance Loans
- Generally intended to provide capital to micro-entrepreneurs.
- While interest rates can appear high (to cover administrative costs for very small loans), the Microfinance NGOs Act and related regulations encourage ethical lending practices.
- Courts still have the power to strike down any rates or fees deemed excessive, regardless of the label “microfinance.”

6. Remedies and Enforcement

6.1 Legal Recourse

Judicial Intervention: Borrowers may challenge an interest provision in court, arguing that the rate is unconscionable. If the court agrees, it may reduce it to a more reasonable rate.
Affirmative Defenses: In a collection suit, the borrower can raise unconscionability, vitiated consent, or lack of disclosure as defenses.

6.2 Regulatory Oversight

BSP: Oversees banks, quasi-banks, and certain financing companies. It can issue regulations aimed at protecting borrowers and can penalize regulated entities that commit abusive lending practices.
SEC: Regulates lending companies and financing companies. It can suspend or revoke licenses for violations of the Lending Company Regulation Act.
Department of Trade and Industry (DTI): Although its focus is broader consumer protection, it can coordinate with other agencies on complaints involving consumer finance.

6.3 Administrative Sanctions

Under the FCPA (R.A. 11765), regulators now have more robust enforcement powers, including administrative sanctions for abusive financial service providers.
Lending companies violating disclosure requirements or engaging in harassment can face fines and license revocation.

7. Practical Tips for Borrowers

Read the Fine Print: Check the nominal interest rate, annual percentage rate (APR), and any hidden fees or penalties.
Compare Lenders: There is growing competition among microfinance institutions and digital lenders. Shop around to find the lowest effective rate.
Document Everything: Keep copies of contracts, receipts, text messages, or emails related to loan transactions.
Seek Help if Harassed: Abusive collection practices, such as threats or public shaming on social media, are prohibited. Report these to relevant authorities (SEC, BSP, or the National Privacy Commission if data privacy is violated).
Consult a Lawyer: When in doubt, especially if you suspect the interest or penalties are excessive, get legal advice. Legal aid groups or public attorneys may be able to help if you cannot afford private counsel.

8. Conclusion

The legal landscape regarding excessive interest rates on short-term loans in the Philippines is shaped by a combination of statutes, BSP regulations, SEC oversight, and the judicial doctrine of unconscionability. While the Usury Law’s rigid interest caps no longer apply, courts remain vigilant in voiding or modifying interest rates that they find patently abusive. Various laws, including the Lending Company Regulation Act and the Financial Consumer Protection Act, impose transparency and fair dealing requirements on lending institutions. Ultimately, the absence of a fixed ceiling demands heightened borrower caution and continuous regulatory enforcement to prevent exploitation.

Short-term loans can serve a legitimate need—particularly for emergency expenses or microenterprise capital—so long as borrowers understand their obligations and lenders act within reasonable bounds. For anyone confronted with steep interest charges, the combined framework of legal recourse and regulatory oversight provides potential remedies, emphasizing the principle that while contracts are generally upheld, they must not violate equity, good morals, or public policy in the Philippines.