Understanding Loan Interest Obligations in the Philippines
(Note: This article is for general informational purposes only and should not be construed as legal advice. For specific concerns, please consult a qualified legal professional.)

1. Introduction

Interest is central to lending and borrowing arrangements, serving both as a lender’s compensation for the use of money and as a measure of damages when an obligation is breached. In the Philippines, loan interest obligations are governed primarily by the Civil Code, the Usury Law (Act No. 2655, as amended), and various Bangko Sentral ng Pilipinas (BSP) circulars. Over time, the Supreme Court has also issued landmark rulings clarifying how interest rates are determined, enforced, and computed in different circumstances.

This article provides an overview of the laws, regulations, and jurisprudence that govern interest obligations on loans in the Philippines.

2. Legal Framework

2.1 The Civil Code of the Philippines

Art. 1956 of the Civil Code states that “[n]o interest shall be due unless it has been expressly stipulated in writing.” Hence, for interest to be charged, there must be a clear, written agreement to that effect.
Art. 2209 of the Civil Code specifies the rate of legal interest in the absence of a stipulated rate, or in cases of delay or default where the interest is imposed by way of damages.

2.2 The Usury Law (Act No. 2655)

The Usury Law historically imposed ceilings on interest rates. Over time, however, various Presidential Decrees and BSP circulars effectively lifted the interest rate ceilings, allowing parties to stipulate their own rates.
While the Usury Law has not been repealed outright, it has been rendered effectively inoperative in terms of fixing a strict maximum rate. Thus, generally, parties are free to determine the interest rates on loans, subject to certain limitations (e.g., rules on unconscionability or public policy).

2.3 Bangko Sentral ng Pilipinas (BSP) Circulars

The BSP, exercising its authority under the law, has issued circulars to guide banks and other financial institutions on the computation and imposition of interest.
BSP Circular No. 799 (2013) is one of the pivotal regulations that aligned the legal interest rate on certain monetary judgments and loan obligations. It set the legal interest rate at 6% per annum for loans, judgments, and awards, replacing the older 12% rate (which was based on previous circulars and the Supreme Court’s rulings prior to 2013).

2.4 Supreme Court Jurisprudence

Two major Supreme Court decisions are frequently cited regarding interest rates:

Eastern Shipping Lines, Inc. v. Court of Appeals (G.R. No. 97412, July 12, 1994)
- Laid down guidelines for determining interest rates applicable to different kinds of obligations (contractual obligation vs. obligation that has become due and demandable, or final judgments).
Nacar v. Gallery Frames (G.R. No. 189871, August 13, 2013)
- Simplified the guidelines from Eastern Shipping Lines and clarified that the legal interest rate for loans and judgments is 6% per annum, following BSP Circular No. 799.

3. Types of Interest in Loan Obligations

When discussing interest on loans, it is important to distinguish between monetary interest (the “price” of the loan) and compensatory or moratory interest (imposed as damages upon delay or default).

Monetary (Stipulated) Interest
- This is the interest rate that parties expressly agree upon in a written contract (e.g., 5% per month, 10% per annum, etc.).
- Philippine law generally permits parties to freely stipulate interest rates, but the courts can reduce unconscionable or iniquitous rates under the principles of equity, public policy, or if it amounts to a “clearly exorbitant” rate.
Compensatory (Moratory) Interest
- This applies when the debtor defaults or fails to pay on the due date, making the obligation “delayed.”
- In the absence of a stipulation, the default rate often follows the legal interest rate, which is currently at 6% per annum based on Nacar v. Gallery Frames.
Judgment Interest
- If a case goes to court and the court orders payment of a sum of money, the interest on the amount awarded is typically set at the legal rate (6% per annum), unless the court decides otherwise or a different rate is stipulated and found to be valid.

4. Freedom to Stipulate Interest Rates and Its Limitations

4.1 Freedom of Contract

Philippine law recognizes freedom of contract: parties may stipulate interest rates that both find acceptable.
This principle promotes a market-based approach wherein competitive forces often guide the interest rates.

4.2 Unconscionable or Iniquitous Rates

Courts can intervene to reduce or nullify interest rates deemed unconscionable or iniquitous.
Although there is no hard-and-fast rule as to what rate is considered “unconscionable,” courts look into the circumstances of each case—such as the relative bargaining positions of the parties, the prevailing market rates, and the level of necessity or distress faced by the borrower.

4.3 Disclosure Requirements

Lenders, especially banks and financial institutions, must comply with disclosure requirements under the Truth in Lending Act (R.A. No. 3765).
They must reveal to the borrower the total cost of the loan, including nominal interest rate, effective interest rate, and other finance charges. Failure to do so can result in administrative or civil liability.

5. Legal Interest Rate When No Rate Is Agreed Upon

When the parties fail to stipulate the interest rate in writing, or when interest is simply mentioned but not quantified, the law applies the legal interest rate of 6% per annum.
Likewise, if the lender charges interest but has no written contract stipulating a rate, no interest can be collected apart from the legal interest that may apply if the borrower is in default.

6. Default, Demand, and Accrual of Interest

6.1 Default and Demand

Under the Civil Code, a debtor is generally considered in default only from the moment the creditor judicially or extrajudicially demands payment, unless the law or a contract explicitly states that default occurs automatically on the due date.
Once a debtor is in default, compensatory interest (at the rate stipulated in the contract or, in the absence of a stipulation, 6% per annum) accrues until full payment is made.

6.2 Accrual of Interest

The accrual date for stipulated interest usually begins from the time the principal amount is released to the borrower, unless the contract says otherwise.
For compensatory interest in case of default, the accrual begins from the date of default.
If a court has entered a final judgment on the amount due, the judgment interest accrues from the time the judgment becomes final and executory until satisfaction.

7. Penalties, Surcharges, and Other Charges

Beyond simple interest, loan agreements commonly include penalty clauses and other charges such as late payment fees, surcharges, or collection charges. While these clauses are generally recognized and enforceable, courts will examine whether:

The penalties are unconscionable or excessive. Courts may reduce the penalty charges if they are found to be excessive or contrary to equity.
There is a duplication of damages. If penalty interest and stipulated interest are both charged, courts evaluate the total effect on the borrower to prevent double recovery for the lender.

8. Judicial Review and Enforcement

8.1 Filing a Legal Action

When a borrower fails to pay, the lender can initiate court proceedings to collect the unpaid principal plus interest (and any penalties, if applicable). Courts typically:

Verify the validity of the loan documents.
Determine if the interest rate is stipulated and valid under Philippine law.
Decide whether the borrower is in default and, if so, apply the legal or stipulated interest.
Determine whether penalty charges are reasonable or must be reduced.

8.2 Extrajudicial Foreclosure (Secured Loans)

If the loan is secured by real estate mortgage or chattel mortgage, the creditor may opt for extrajudicial foreclosure proceedings under Act No. 3135 (as amended) and Act No. 1508 (chattel mortgages). These allow the creditor to sell the mortgaged property at a public auction. The sale proceeds are applied to the debt, interest, and other charges, with any surplus returning to the debtor.

9. Key Supreme Court Doctrines on Interest

Freedom to Stipulate, Subject to Equity
- The Supreme Court consistently holds that parties may agree on any interest rate, but it can be struck down or reduced if found to be exorbitant, iniquitous, or unconscionable (e.g., rates exceeding industry standards by a wide margin).
Nacar v. Gallery Frames
- This case confirmed the 6% per annum legal interest for judgments and loans when there is no stipulation or when the stipulated rate is declared void.
Principle of Double Recovery
- If both penalty interest and compensatory interest are due, courts may moderate the total amount so that the lender does not recover more than what equity and law allow.

10. Practical Tips for Borrowers and Lenders

Put Everything in Writing
- Ensure that the loan agreement, including the interest rate, payment schedule, penalties, and charges, is in a written contract.
- This avoids confusion and simplifies enforcement.
Disclose and Understand All Charges
- Borrowers should request a disclosure of the effective interest rate, not just the nominal rate.
- Lenders are legally obligated to comply with disclosure requirements.
Avoid Unconscionable Rates
- While there is no absolute cap on interest rates, extremely high rates may be reduced or voided by the courts.
- Seek a fair market rate that aligns with current banking and lending practices.
Monitor BSP Circulars and Market Conditions
- The BSP may issue new circulars that impact the prevailing legal interest rates, especially on judgments or specific lending sectors.
Consider Prepayment and Negotiation
- Some loan contracts allow prepayment without penalty or with a reduced charge, which can lessen overall interest.
- If a borrower encounters financial difficulties, negotiating with the lender early may prevent default and additional penalties.

11. Conclusion

In the Philippine setting, loan interest obligations are guided by a combination of statutory provisions, BSP regulations, and Supreme Court jurisprudence. While the Usury Law is effectively no longer in force in terms of fixed ceilings, courts remain vigilant against interest rates that are unconscionable or against public policy. The prevailing legal interest rate stands at 6% per annum, which operates as the default rate when no written stipulation exists or when a stipulated rate is invalid.

Whether you are a lender drafting loan terms or a borrower seeking financing, it is crucial to understand your rights and obligations regarding interest. Always ensure that all terms—especially the interest rate—are in writing, fair, and fully compliant with disclosure requirements. In case of ambiguity or disputes, seeking professional legal advice is the best way to safeguard your interests.

Disclaimer: This article is for general information only. It does not constitute legal advice nor create an attorney-client relationship. For questions specific to your situation, consult a licensed attorney or other qualified legal professional.