Interest is how a lending business earns, but it is also where borrowers get confused and disputes begin. A rate quoted carelessly can mean two very different amounts of money. This guide gives you the mental model to compute interest correctly and to explain it honestly — which is both good business and a legal requirement in the Philippines.
The three variables that define interest
Whenever you compute interest, three things must be pinned down. The rate (say 3%), the period that rate applies to (per month? per year?), and the base the rate is charged on (the original principal, or the declining balance). Change any one and the cost changes. Most confusion in Philippine lending comes from leaving one of these vague.
Per month vs per annum: a 12× difference
The single biggest source of confusion is the period. "3% per month" is not "3% per year." Three percent per month is roughly 36% per year (before compounding) — twelve times more expensive than 3% per annum. In Philippine micro-lending, rates are often quoted per month, so a "3%" loan may cost far more than a borrower unfamiliar with the convention assumes. Always state the period explicitly, in writing.
| If "3%" means… | Approx. annual rate | Interest on ₱10,000 for 1 year |
|---|---|---|
| 3% per annum | 3% | ~₱300 |
| 3% per month (add-on) | ~36% | ~₱3,600 |
Add-on vs diminishing: the base matters
The base is the second trap. Under the add-on method, interest is charged on the full original principal for the whole term, even as the borrower pays it down — so a 3% add-on rate has an effective cost noticeably higher than 3%. Under the diminishing balance method, interest is charged only on the remaining balance, so the quoted rate is close to the true rate. The same 3% produces different total interest depending purely on which base you use. (For a deeper dive, see our guide on amortization methods.)
A ₱10,000 loan at "3% per month for 12 months" on the add-on method charges ₱3,600 total interest — but because the borrower is repaying throughout, the effective annual rate is well above 36%. Disclosure closes that gap.
The number that matters: Effective Interest Rate
Because rate, period, and base can each hide cost, the honest measure is the Effective Interest Rate (EIR) — the single annualized percentage that captures the real cost of the loan, including how it is amortized and any finance charges rolled in. The Truth in Lending Act (RA 3765) requires lenders to disclose the finance charge and effective rate to the borrower before they sign. Computing the EIR isn't just compliance; it is what lets a borrower compare your loan fairly and trust your numbers.
A full worked example
Let's build one loan end to end. A borrower takes ₱20,000 at 3% per month for 6 months on the add-on method. Total interest is ₱20,000 × 3% × 6 = ₱3,600, so the total payable is ₱23,600, split into six installments of about ₱3,933 each. On paper the "rate" is 3% a month — but watch what the borrower actually experiences.
By the third installment the borrower has already repaid half the principal, yet the add-on method still charged interest as if the full ₱20,000 were outstanding the whole time. Compute the effective interest rate across the schedule and it lands well above the nominal 36% per year — because the borrower loses the use of money they've already repaid while still paying interest on it. This is the exact gap the Truth in Lending Act targets: the loan is legal and the math is simple, but the borrower deserves to see the effective rate, not just the headline 3%. Disclosing both numbers is what separates a trustworthy lender from a predatory one.
Let the engine compute and disclose
Doing this by hand for every loan — across seven possible methods and different periods — invites both math errors and disclosure gaps. LendKoPH computes interest for whichever method and period you choose, builds the amortization schedule, and surfaces the figures you need to disclose the true cost. You quote the rate; the system makes sure the borrower sees exactly what it means.
Interest is simple once you respect the three variables. Nail down the rate, the period, and the base, compute the effective rate, and put it in writing — and you'll have borrowers who trust you and books that stand up to scrutiny.
Frequently asked questions
Is 3% per month the same as 3% per year?
No. 3% per month is roughly 36% per year (before compounding) — about twelve times more expensive. Always state whether a rate is per month or per annum, in writing.
What is the effective interest rate?
The single annualized percentage that captures the true cost of a loan, accounting for how it is amortized and any finance charges. It is the honest number for comparing loans, and the Truth in Lending Act requires disclosing it.
Why does add-on interest cost more than it looks?
Because interest is charged on the full original principal for the entire term even as the borrower pays down the loan, so the effective rate is higher than the quoted rate.
Am I legally required to disclose the interest cost?
Yes. The Truth in Lending Act (RA 3765) requires lenders to disclose the finance charge and effective interest rate to the borrower before the loan is signed.
