Here we explain the different methods used by bridging lenders to calculate interest on bridging loans, detailing the differences between roll-up interest, retained interest and serviced interest.
We explain in detail why retained interest is less favourable to borrowers than roll-up, and how it comes to cost that much more.
Unlike most mortgages and loans, where interest rates are typically quoted as an annual percentage, bridging loan rates are usually expressed as a monthly percentage. For example 0.75% per month (which is equivalent to 9% pa)
The main reason for this is due to the short-term nature of bridging finance. Bridging loans can run for only a few months, so quoting the interest rate on a monthly basis, makes it easier for borrowers to understand and estimate the likely cost of the loan, rather than working from an annual figure then dividing it down.
For example: If working out how much interest there is on a £100,000 loan that is paid back after 2 months, it is easier to work with 0.75% per month than with 9% pa.
When comparing different bridging loan options, it is important to understand how the interest is calculated, because there are three different methods that lenders use:
It is often not very clear on loan offers or agreements which method is used.
Each method can affect the overall cost of the loan, so it is important to understand the differences to help assess which potential loan option offers the best value, whilst also considering how a serviced interest option will affect cash flow during the loan term.
The vast majority of bridging loans are taken out with roll-up or retained interest, because borrowers do not want the added burden of making monthly interest payments, especially when the loan is being used to fund a building project or a house move.
Regulated bridging loans use roll-up interest, a method when compared to retained interest, favours the borrower.
Unregulated bridging loans can use either roll-up or retained methods. However, they are usually written using retained interest, which is more favourable to the lender. A small number of lenders do write their unregulated bridging loans using the roll-up method, which in our opinion is a very good practice.
With roll-up interest, the interest is added to the loan balance each month, where it compounds on the increasing balance. It is then paid when the loan is redeemed.
This means the borrower does not have to make any monthly interest payments during the term of the loan.
For example
A £100,000 net loan (the borrower receives £100,000) charged at 1% per month, using roll-up interest would be charged interest as follows:
| Loan amount | £100,000 | |
|---|---|---|
| Month | ||
| 1 | £1,000 | £101,000 |
| 2 | £1,010 | £102,010 |
| 3 | £1,020 | £103,030 |
| 4 | £1,030 | £104,060 |
| 5 | £1,041 | £105,101 |
| 6 | £1,051 | £106,152 |
| 7 | £1,062 | £107,214 |
| 8 | £1,072 | £108,286 |
| 9 | £1,083 | £109,369 |
| 10 | £1,094 | £110,462 |
| 11 | £1,105 | £111,567 |
| 12 | £1,116 | £112,683 |
| Total loan amount after 12 months | £112,683 | |
| Total interest charged | £12,683 | |
| Compound interest - amount charged | £683 | |
Please Note: Our bridging loan calculator uses the roll-up interest method for its quotes.
With retained interest, the lender calculates the interest for the full agreed term of the loan at the outset and deducts it from the loan when the funds are released. Similar to the roll-up method, no monthly payments are required to be made.
If the loan is repaid earlier than expected, most lenders will refund the unused portion of the retained interest, although this will depend on the lender’s terms and conditions, so this is something to look out for and check when choosing which lender you would like to use.
An simple example of retained interest: A borrower visits a lender who lends them £100,000 in cash for 12 months, at 1% per month on a retained basis. Before passing the £100,000, the lender first removes 12 months interest at 1% per month from the loan amount. This therefore leaves the borrower with a net £88,000 (£100,000 gross - £12,000 interest = £88,000 net). So, in effect the borrower actually has a loan of £88,000 and they have to pay back to the lender £100,000 in 12 months time.
This may look strange to the borrower who has £88,000 in his hand but their first monthly interest charge at 1% per month is £1,000 and not the £880 that they may have expected.
If the borrower had instead borrowed £88,000 at 1% per month on a roll up interest basis, his first monthly interest charge would have been £880.
A comparison example
A £100,000 net loan charged at 1% per month using retained interest:
| Loan amount | £100,000 | |
|---|---|---|
| Month | ||
| 1 | £1,136 | £101,136 |
| 2 | £1,136 | £102,272 |
| 3 | £1,136 | £103,409 |
| 4 | £1,136 | £104,545 |
| 5 | £1,136 | £105,681 |
| 6 | £1,136 | £106,818 |
| 7 | £1,136 | £107,954 |
| 8 | £1,136 | £109,090 |
| 9 | £1,136 | £110,227 |
| 10 | £1,136 | £111,363 |
| 11 | £1,136 | £112,499 |
| 12 | £1,136 | £113,636 |
| Total loan amount after 12 months | £113,636 | |
| total interest charged | £13,636 | |
| Difference between Roll-Up and Retained | £953 | |
The tables above show that, on a £100,000 loan at 1% per month over a 12-month term, the roll-up method produces a lower overall cost for the borrower than retained interest. In this example, roll-up is £953 cheaper, which is slightly less than the equivalent of one month’s interest.
Please Note: You can calculate retained interest by using our retained interest calculator.
If the term is extended to 18 months, the difference becomes even more significant. As shown in the table below, the additional cost of retained interest, when compared to roll-up, rises to £2,291 by the end of the full 18-month term.
| Loan amount | £100,000 | |||||||
|---|---|---|---|---|---|---|---|---|
| Month | Paid Monthly | Roll-up Interest | Retained Interest | |||||
| 1 | £1,000 | £100,000 | £1,000 | £101,000 | £1,219 | £101,219 | ||
| 2 | £1,000 | £100,000 | £1,010 | £102,010 | £1,219 | £102,438 | ||
| 3 | £1,000 | £100,000 | £1,020 | £103,030 | £1,219 | £103,657 | ||
| 4 | £1,000 | £100,000 | £1,030 | £104,060 | £1,219 | £104,876 | ||
| 5 | £1,000 | £100,000 | £1,041 | £105,101 | £1,219 | £106,095 | ||
| 6 | £1,000 | £100,000 | £1,051 | £106,152 | £1,219 | £107,314 | ||
| 7 | £1,000 | £100,000 | £1,062 | £107,214 | £1,219 | £108,533 | ||
| 8 | £1,000 | £100,000 | £1,072 | £108,286 | £1,219 | £109,752 | ||
| 9 | £1,000 | £100,000 | £1,083 | £109,369 | £1,219 | £110,971 | ||
| 10 | £1,000 | £100,000 | £1,094 | £110,462 | £1,219 | £112,190 | ||
| 11 | £1,000 | £100,000 | £1,105 | £111,567 | £1,219 | £113,409 | ||
| 12 | £1,000 | £100,000 | £1,116 | £112,683 | £1,219 | £114,628 | ||
| 13 | £1,000 | £100,000 | £1,127 | £113,809 | £1,219 | £115,847 | ||
| 14 | £1,000 | £100,000 | £1,138 | £114,947 | £1,219 | £117,066 | ||
| 15 | £1,000 | £100,000 | £1,149 | £116,097 | £1,219 | £118,285 | ||
| 16 | £1,000 | £100,000 | £1,161 | £117,258 | £1,219 | £119,504 | ||
| 17 | £1,000 | £100,000 | £1,173 | £118,430 | £1,219 | £120,723 | ||
| 18 | £1,000 | £100,000 | £1,184 | £119,615 | £1,219 | £121,942 | ||
| Total | £18,000 | £19,615 | £21,942 | |||||
The difference is even more evident if the loan is repaid early. For example, if an 18 month loan is paid off after 12 months, a roll-up loan will cost the same as if it had originally been set up for 12 months, because interest is only charged for the time the loan is actually outstanding.
When compared to roll-up, the cost for retained interest is higher. This is because the interest is calculated and deducted upfront based on the full original term of the loan. So, the longer the loan is set up for at the start, the more expensive it will be to repay early under a retained interest structure. This is not because of a penalty clause in the loan agreement (although these may also exist meaning even more costs), it is simply the result of the way the interest is calculated.
In practical terms, this means a loan using retained interest instead of roll up, can cost about the same as paying an extra month’s interest over a 12-month term. Over an 18-month term, the difference can be closer to two months interest, as seen in the diagram above.
When compared to roll-up interest, you only pay for the time the loan has actually been running, so the original length of the loan term does not affect the interest charged if you repay early.
With serviced interest, the borrower pays the interest each month, similar to a traditional mortgage. The loan balance does not increase, because the interest is paid as it accrues. This option is usually chosen by borrowers who have sufficient income or cash flow to comfortably cover the monthly payments.
| Loan amount | £100,000 | |
|---|---|---|
| Month | ||
| 1 | £1,000 | £100,000 |
| 2 | £1,000 | £100,000 |
| 3 | £1,000 | £100,000 |
| 4 | £1,000 | £100,000 |
| 5 | £1,000 | £100,000 |
| 6 | £1,000 | £100,000 |
| 7 | £1,000 | £100,000 |
| 8 | £1,000 | £100,000 |
| 9 | £1,000 | £100,000 |
| 10 | £1,000 | £100,000 |
| 11 | £1,000 | £100,000 |
| 12 | £1,000 | £100,000 |
| Total loan amount after 12 months | £100,000 | |
| Total interest charged | £12,000 | |
| Compound interest - amount charged | £0 | |
Paying the interest each month, or adding it to the loan, both have their advantages depending on the borrower’s circumstances.
For serviced interest borrowers will need to be able to demonstrate that they can afford to make the monthly repayments, something that is not usually required for roll-up or retained interest options.
By making the payments each month this avoids any compound interest, and also the disadvantages that come with retained interest.
Some bridging loans can be set up with a combination of interest being added and monthly payments being made.
For example:
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