Below is a general overview of the legal principles and jurisprudential guidelines in the Philippines concerning the imposition of compound interest—often referred to as “interest on interest”—in the absence of a written agreement. This discussion covers the statutory provisions, notable Supreme Court rulings, and practical considerations that shape the limits and enforceability of compound interest under Philippine law.

1. Foundational Legal Provisions on Interest in the Philippines

1.1. The Civil Code of the Philippines

Article 1956 (No Interest Without Written Stipulation)

“No interest shall be due unless it has been expressly stipulated in writing.”

This provision requires that an agreement to pay interest—whether simple or compound—be set down in writing. Without a written contract specifying an obligation to pay interest, a creditor cannot unilaterally impose or collect interest.
Article 1959 (No Compound Interest Without Express Stipulation)
Although the Civil Code does not literally state “compound interest is disallowed without express stipulation,” the broader principle under Article 1959 is that “interest due and unpaid shall not earn interest,” except in very specific circumstances. This is generally interpreted to mean that compound interest (i.e., interest charged on accrued and unpaid interest) cannot be collected unless clearly agreed upon and stated in writing.
Article 2212 (Judicial Demand and Legal Interest)

“Interest due shall earn legal interest from the time it is judicially demanded, although the obligation may be silent upon this point.”

This provision pertains mostly to post-litigation scenarios, allowing interest to accrue on unpaid interest once judicially demanded. Courts often rely on this provision when awarding “legal interest,” but the key is that it applies to litigation situations rather than forming a blanket rule for contractual obligations.

1.2. Usury Law and Central Bank (BSP) Regulations

Act No. 2655 (Usury Law)
Historically, the Usury Law imposed ceilings on the amount of interest that could be charged. Over time, various Presidential Decrees and Central Bank Circulars have effectively relaxed or suspended these ceilings, allowing parties to contract freely on interest rates. However, courts still have the power to reduce “unconscionable” interest rates.
Central Bank Circulars
- Central Bank Circular No. 905 (1982) rendered the Usury Law “practically inoperative” by removing the maximum rate caps, subject to the power of courts to moderate unconscionable rates.
- BSP Circular No. 799 (2013) reduced the legal interest rate on loans or judgments from 12% to 6% per annum in certain scenarios.
- These regulations underscore the principle of “freedom to stipulate” on interest rates, including compound interest, provided it is expressly agreed upon in writing and not unconscionable or contrary to public policy.

2. Understanding Compound Interest Under Philippine Law

2.1. Definition of Compound Interest

Compound interest (sometimes called “interest on interest”) arises when interest due becomes part of the principal, so that subsequent interest charges are based on the accumulated sum (principal + previously accrued interest). In practice, creditors or financial institutions may attempt to impose compounding to accelerate the growth of interest on a debt.

2.2. Requirements for Valid Compounding

Written Agreement
As mandated by Article 1956 of the Civil Code, any form of interest—simple or compound—requires an express, written stipulation. For compound interest specifically, creditors and debtors must explicitly agree in writing to allow unpaid interest to be added to the principal for the purposes of calculating subsequent interest.
Clear and Unambiguous Terms
The contractual clause providing for compound interest must be stated clearly. If the wording is vague or ambiguous, courts will typically interpret the ambiguity against the party attempting to impose compound interest (usually the creditor).
Not Unconscionable
Even if compound interest is explicitly mentioned, courts can still declare the rate or effect of compounding to be unconscionable (exorbitant or oppressive). Courts will step in to reduce or void such stipulations under the principle that contractual freedom does not extend to imposing outrageously high or unjust terms.

2.3. Effect of No Written Stipulation

No Right to Collect Compound Interest
Without an express written provision allowing compounding, a creditor generally cannot legally charge “interest on interest.”
Reversion to Legal Interest
If a written contract is silent on interest, or if the original contract has an interest clause but is silent on compounding, courts may still impose the legal interest rate (currently 6% per annum on certain obligations) on the principal amount only.
Judicial Demand and Accrual
If a creditor sues for payment of the debt, the unpaid interest (if any is legally due under a valid stipulation) may begin to earn legal interest from the time of judicial demand, pursuant to Article 2212 of the Civil Code. This is a limited type of “compounding” mandated by law for judicial awards, distinct from a purely contractual arrangement.

3. Jurisprudential Guidance

Philippine Supreme Court rulings reinforce the statutory framework:

Necessity of a Written Contract for Interest
The Supreme Court has consistently held that “no interest shall be due unless it has been expressly stipulated in writing.” If a creditor fails to produce any written evidence or contractual provision specifying interest—much less compound interest—courts will deny the claim for interest altogether.
Prohibition Against Compound Interest in Absence of Specific Stipulation
Courts often refer to Articles 1959 and 2212 of the Civil Code, distinguishing simple interest (principal x interest rate) from compound interest (principal + accrued interest x interest rate). Without explicit language in the agreement, imposing compound interest violates the general rule disallowing interest on accrued interest.
Reduction of Unconscionable Rates
Even when compound interest is in writing, the Supreme Court can and does reduce or nullify the rate if it is found to be “excessive,” “unreasonable,” or “unconscionable.” This power is rooted in equity, the Civil Code, and the prerogatives retained by the judiciary despite the suspension of the Usury Law ceilings.

4. Practical Considerations and Common Scenarios

Verbal Agreements
Purely verbal agreements, even with a handshake or acknowledgment, are insufficient to justify charging interest. Written documentation is a prerequisite for any interest. Without it, a creditor can only recover the principal.
Loan Agreements and Promissory Notes
- Look for Specific Clauses: Lenders sometimes embed a “compounding clause” in standard loan forms, stating that any unpaid interest at the due date becomes part of the principal.
- Interest Rate “Per Annum” vs. “Per Month”: Pay close attention to the numeric rate (e.g., “2% per month” equals 24% per annum if it is not compounding). If the agreement also says interest capitalizes monthly, it indicates compounding.
- Mortgage Contracts: Real estate mortgages and credit facilities from banks may contain explicit compound interest provisions in the “penalty” or “default interest” sections.
Credit Cards and Other Consumer Loans
Credit card issuers commonly impose monthly interest on unpaid balances, effectively resulting in compound interest if the borrower fails to pay the total amount due. The validity of these charges typically rests on the terms and conditions that cardholders sign when opening the account.
Demand Letters and Litigation
- Date of Judicial Demand: Once a complaint is filed in court to recover a debt, interest can start running on unpaid interest (if validly stipulated) at the legal interest rate (usually 6% per annum).
- Court’s Equitable Powers: Even if the original contract mentions compounding, the court may moderate the imposition if it deems the arrangement oppressive or lacking sufficient clarity.

5. Summary of Key Points

Express Written Stipulation Is Mandatory
- No written agreement = no interest.
- A mere mention of “interest” is not enough for compound interest; the agreement must explicitly state that accrued interest becomes part of the principal.
Compound Interest Absent a Written Clause Is Void
- Philippine law generally disallows compound interest (interest on interest) without a clear written basis.
The Court Retains the Power to Intervene
- Even with a written clause, the court can reduce or nullify the rate if deemed unconscionable.
- During litigation, unpaid interest may earn legal interest from the time of judicial demand, but this is grounded in law rather than purely contractual compounding.
Legal Interest Rates and Default Provisions
- If no specific rate is stipulated (or if the written stipulation is void), the court may impose the prevailing legal interest rate (currently 6% per annum under BSP Circulars and Supreme Court jurisprudence on judgments).
- This interest applies only to the principal unless there is a valid compounding agreement or a judicial award of interest on interest.
Importance of Clarity in Contracts
- Vague or ambiguous provisions on interest are construed against the party that drafted the agreement.
- Lenders seeking to impose compound interest should ensure the language is unmistakable and the rate is not oppressive.

6. Concluding Remarks

In the Philippine legal landscape, the imposition of compound interest without a written agreement is effectively prohibited. The Civil Code and jurisprudence emphasize that interest—especially compound interest—must be explicitly stated in writing. Absent such stipulation, no interest will be due beyond what the law provides for judicial or legal interest. Furthermore, even when there is a formal agreement to compound interest, courts retain the discretion to strike down or reduce arrangements that are unconscionably high or contrary to public policy.

For parties entering into loan contracts or other financial agreements, clarity and precision in drafting interest clauses are crucial. Borrowers, on the other hand, should be aware of their rights and protections under the Civil Code, especially the requirement that compound interest must be expressly provided for in writing and subject to reasonableness. Where disputes arise, courts will look at both the letter of the contract and the fairness of the stipulated interest to determine whether it should be enforced or moderated.

Disclaimer: This article is provided for general informational purposes and does not constitute legal advice. Individuals or entities facing specific legal issues regarding compound interest or related matters should consult a qualified attorney to obtain advice tailored to their particular circumstances.