Five mortgage intermediaries face punishment after the City watchdog uncovered widespread problems in the way home loans were sold to people with poor credit histories.

Announcing the findings of a six-month review of the sub-prime sector, the Financial Services Authority (FSA) admitted yesterday that it was surprised by the number of sales errors made by both lenders and brokers.

Mandy Spink, head of mortgages at the FSA, said: “It was worse than we’d hoped. We’re concerned by the findings.”

The watchdog found that “significant numbers” of consumers had been advised by intermediaries to remortgage their houses, incurring early repayment charges, without good reason. Half of intermediaries did not check whether their customer could afford to repay their mortgage.

Lenders did not check whether customers had lied on their application forms, and approved unaffordable loans.

Sub-prime mortgages are aimed at people with bad credit histories. The FSA’s review concentrated on a sub-sector called impaired credit mortgages, which are sold to people with county court judgments against them or who have been in arrears or with previous bankruptcies.

The FSA reviewed 11 lenders and 34 intermediaries. Although five face discipline, which can range from a fine to a ban from doing business, a larger number will work with the regulator’s staff to improve their practices.

“There were firms that were doing the right thing, but there were a larger proportion than we hoped who weren’t running their businesses in the way we’d like,” Ms Spink said.

The Association of Mortgage Intermediaries (AMI) said yesterday that it would set up a working party with the Council of Mortgage Lenders to look at the problem. But AMI policy director Tracey Mullins said that the criticisms should be “kept in perspective”. “They haven’t found any evidence of consumer detriment,” she said.

Mortgages have been FSA-regulated for three years, but many of the small intermediaries still struggled to cope with the paperwork, Ms Mullins said. Intermediaries are paid higher commissions to sell sub-prime products – from 1 to 1.5 per cent, compared to 0.35 to 0.5 per cent on a prime mortgage.