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THE PROBLEMS WITH BRIDGING LOANS PART I – INTEREST PRICING

Bridging loans are, by their very nature an expensive form of borrowing. This is due to the nature of the risk, and the short tenor of bridging loans. Lenders need to make enough of an interest return to compensate them for the risk, and as most bridging loans are for durations of up to 12 months, many are repaid well before the 12-month term.

Because of the short-term nature, interest is charged on a simple monthly basis, so for example, 1% per month. This is very different from term loans, where interest is charged on an annual percentage rate basis. 1% per month is equivalent to 12% per annum.

In addition, lenders often charge the interest within the amount of the loan, for example, a loan where the borrower needs £80,000 might be a loan for £90,000 where the £10,000 interest is recouped by the lender at the end of the loan.

Interest per month on bridging loans tends to be in the region of between 1.00% and 1.50% per month.

Default interest is more of a thorny issue. In the event of default during the term of the bridging loan, or at maturity if the borrower does not repay the loan, interest per month rises from 1% per month (for example) to a higher percentage, often 3% per month.

With both normal interest and default interest there is an additional question of compounding. Compounding is where interest is charged on interest, and it means the total interest paid can become much higher.

There have been some court cases where the level of interest charged in the event of default has been a key issue. Most often the issue has been brought under Unfair Relationships under the Consumer Credit Act.

In early cases any default interest rate in excess of 3% per month was described in the courts as a ‘stiff commercial bargain’. More recently however, in Houssein vs London Credit Limited, the judge ruled (having taken input from two expert witnesses) that there was an industry norm of 3% per month for default interest, and that this rate correctly and adequately recompensed the lender in the event of default, in terms of the additional administration and cost of exercise of rights under the security (i.e., to get control of the underlying property), and anything above 3% was not in compensation for the default, it was a ‘penalty’. Given that there was already sufficient protection for the lender, in that it could seize the property, sell it and make itself whole again, the judge ruled that anything over 3% was not enforceable.

I plan to write on other issues attached to bridging loans over the next few days and weeks. I have acted as expert witness in several cases now, writing expert reports and providing testimony in court.

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