Can a lender charge interest on interest that has already fallen due and gone unpaid?

The default is against compounding

Article 1959 provides that interest due and unpaid shall not earn interest. However, the contracting parties may by stipulation capitalize the interest due and unpaid, which as added principal, shall earn new interest. The structure is a rule and a permission. Left alone, arrears of interest sit as arrears; they are owed, they may be sued for, but they do not themselves generate further interest. Compounding is available only because the parties provided for it, and the provision has to do more than authorise interest generally. It has to convert the unpaid interest into principal.

What a valid stipulation has to say

Read the loan document for the mechanism rather than the label. The article speaks of capitalizing the interest due and unpaid so that it becomes added principal, so a clause that simply says interest is compounded monthly, without saying that arrears are added to principal, is worth checking closely. Remember too that Article 1956 requires that no interest shall be due unless it has been expressly stipulated in writing. A lender who cannot point to a written stipulation for the primary interest is in no position to argue about interest upon it.

The exception the article preserves

Article 1959 opens by saving Article 2212, which provides that interest due shall earn legal interest from the time it is judicially demanded, although the obligation may be silent upon this point. That is a narrow and specific carve-out. It does not let a lender compound arrears as they accrue during the life of the loan; it attaches from the point of judicial demand, and it operates whatever the contract says or fails to say. So the date a case was filed can matter to the computation quite apart from anything the parties agreed.

Checking a statement of account

Borrowers usually meet this issue as an unexplained balance rather than as a legal question. Ask the lender for the computation, not the total, and follow what happened to each month's unpaid interest: whether it stayed in an arrears column or was folded into the principal that the next month's rate was applied to. Then set that against the contract. Where interest was capitalised without a stipulation permitting it, the objection goes to the amount claimed, and it is far easier to raise while the account is being reconciled than after a payment schedule has been signed.

Cases citing this provision

These Supreme Court decisions cite the provision above. We list them so you can read them yourself; the summaries of what each decided are not ours to give.

• Lara's Gifts & Decors, Inc. vs. Midtown Industrial Sales, Inc, G.R. No. 225433, September 20, 2022 — read the decision on LawPhil →
• Antonio Tan vs. Court of Appeals, et al, G.R. No. 116285, October 19, 2001 — read the decision on LawPhil →
• Metro Alliance Holdings and Equities Corporation, Polymax Worldwide Limited and Wellex Industries, Inc., G.R. No. 240495 / G.R. No. 240513, September 15, 2021 — read the decision on LawPhil →
• Erma Industries, Inc. vs. Security Bank Corporation and Sergio Ortiz-Luis, Jr. Oca No. IPI 15-4429-P December 6, 2017 Isagani R. Rubio vs. Igmedio J. Basada, Court Legal Researcher Ii, Branch 117, Regional Trial Court , Pasay City, G.R. No. 191274, December 6, 2017 — read the decision on LawPhil →

Related provisions

• Civil Code, Article 1959 — Interest on Interest (Compounding)
• Civil Code, Article 1956 — Interest Must Be Stipulated in Writing
• Civil Code, Article 2212 — Compounding of Interest
• Civil Code, Article 1960 — Payment of Interest Not Stipulated