Following the FSA’s letter to a number of regulated bridging lenders late last month warning them about ‘unclear, unfair and misleading’ product interest rates, B&C heard from a compliance expert about exactly what the FSA are referring to and the effect this may have on the industry as a whole.

The FSA has expressed concern that the way some bridging lenders calculate interest may not comply with its Mortgages and Home Finance Conduct of Business Rules. The example cited in a letter to lenders is that of retained interest, which refers to the practice of the consumer borrowing the interest payments on the loan as well as the loan amount required. The lender holds the interest, using it to meet the monthly payments. Interest is, effectively, charged on the interest that has been added to the loan.

An FSA spokesperson explained that the regulator has written to regulated bridging lenders because it wants “the firms involved to take steps to identify where they are in breach and implement changes where necessary. 

“Furthermore, if appropriate, they should pay redress to customers. We will be closely monitoring how bridging firms respond to this letter." 

Compliance expert Ray Cohen of Jackson Cohen said that what the FSA is focusing on is clarity for the consumer about exactly how much the loan will cost them and transparency about the calculation methods used.

Ray commented: “At this stage it remains to be seen whether firms will challenge the FSA’s view and some of that may depend on how they have set out the KFI and how the product is marketed and sold. 

“Headline rates have never been the basis on which bridging products have been sold and all regulated loans have to have a total cost of borrowing, cost per pound lent and an APR which show the borrower how much the loan costs to meet the FSA’s requirements in order that consumers understand the cost of their loan.”

When the regulator utilises Section 165 of the Financial Services and Markets Act 2000 – as it has done here by requesting regulated lenders to fill out a questionnaire – it can request information only, rather than taking further action and forcing redress. 

The FSA has also confirmed that it held a meeting with a number of regulated bridging lenders back in February of this year, during which the issue of the calculation of retained interest was raised as something it would be looking at more closely.

Ray explained that if the FSA forces firms to make redress (and it is possible this redress could extend as far back as M-day in 2004) then “the worst case scenario is that some lenders could be forced out of business.

“From an on-going perspective, if the use of retained interest is not allowed then some lenders may struggle to obtain funding on a rolled up interest basis and others may well find that the cost of borrowing significantly increases for raising funds on a non-performing basis and this cost will, inevitably, be passed on to the consumer.” 

Rolled up interest adds the interest due each month to the existing loan balance. The interest is calculated each month based on the balance then outstanding. 

With retained interest, bridging lenders’ funders are paid each month and therefore know exactly how the loan is performing. Rolled up interest involves funders being paid at the end of the term and the cost of funds can therefore be more expensive.

It is not yet clear whether the FSA will look at the calculation of rolled up interest and issue letters about lack of clarity in the same way as it has done with retained.