Beware of the actual interest on bridging loans

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Short-term finance to help the move from one home to another is common.

It is a fraught time and often the financial calculations are on a knife edge. Frequently, the exact period that a loan is required is unknown and the lender is not the one providing the mortgage.

It is vital therefore that any interest rate quoted is accurate. Yet the Financial Services Authority (FSA) last month said some bridging loan providers may have advertised rates which were both “unfair and misleading”.

Specialist finance firms have entered this sector in the last five years to fill the gap formerly undertaken by traditional banks and building societies.

Often the money is needed when a property is purchased at auction and the deposit is required almost immediately. Sometimes funds are applied to avoid a break in the housing chain.

The FSA considers that some bridging loan providers are not quoting the true cost of the finance.

They advise an initial interest rate but then alter it to a rate based on the combined principal and interest.

The euphemism used for such a tortuous calculation is ‘retained interest’.

To show its real impact on a bridging loan of £100,000 over six months, an applicant may have closely calculated that £7,500 interest would be paid if an interest of 1.25 per cent a month had been advertised.

In reality, the provider would invoice over £8,000, which means a far higher rate.

The combative Association of Short Term Lenders is the trade body that defends such dubious practices.

It claims that “the use of retained interest has never been hidden from the FSA”.

Instead lenders say that their advertised rates form part of the cost of a bridging loan and clients should rely instead on the actual documents issued.

Of course, the paperwork should be accurate but no prospective customer should be lured into taking on finance through a clearly misleading operation.

The time for discussion is over.

The FSA should take urgent action now to fine the culprits and stamp out the practice.