Bridging finance is a short-term loan. It is usually charged at higher interest rates than those levied on straightforward mortgage finance, but the ways in which interest is charged are rather confusing.

Retained interest

With loans taken out on a retained interest basis, the borrower isn’t required to make any monthly interest payments. Instead, at outset, the lender adds all the interest to the balance of the loan and effectively pays the interest itself when it falls due at the end of each month.

So if you want to borrow £100,000 for a year then the actual amount you have  to borrow might be, say, £114,000 – once all fees and interest charges have been factored in.

Another way to look at it is that you are borrowing the interest payments on top of the actual loan. The controversial aspect of retained interest, and this is where the FSA thinks there may be a problem (more on which below) is the fact that the lender charges interest on top of the interest already added to the loan. So it’s effectively a double whammy.

Rolled-up interest

With loans taken out on a rolled-up interest basis, the borrower once again isn’t required to make any monthly interest payments (often in bridging,  borrowers want to be free of any regular payments during the term of the loan). Instead, and as with retained interest above, the lender rolls up the interest and adds that interest to the balance of the loan at outset.

Where rolled-up interest differs to retained interest is that the lender does not charge interest on the interest already added to the loan. With both rolled-up and retained interest, note that the loan plus any interest rolled-up cannot exceed the lender’s maximum LTV criteria.

Serviced interest

As with mainstream mortgages, this is where the interest that accumulates is paid off on a monthly basis, which means only the loan principal is paid on redemption. 

Media interest in interest

In recent months, you may well have seen a fair bit of media interest surrounding ‘retained interest’. This is because the FSA are concerned that, over the years, this method of calculating interest may not have been explained transparently enough to borrowers – and in a number of cases may even have been deliberately misleading. Whether or not this is true remains to be seen but expect to see more developments on this front in the weeks and months ahead. There is every chance some lenders will have to pay redress, which could put many of them under real financial pressure.

Step forward, not step back

Some have argued that the FSA’s sudden interest in, well, interest, has been a set-back for the short-term finance sector. As I see it, it’s quite the opposite and a step in the right direction. The increased interest of the regulator in the short-term finance sector reflects how much the industry has come on in recent years. Anyone involved in bridging and the specialist finance sector wants the FSA to be more involved, as this will lead the sector to mature, to become more transparent and encourage everyone in it to get their ducks in order. That will make for a far more rounded and successful sector in the long term – and create all-important consumer trust.

Danny Waters is CEO of Enterprise Finance