Bridging finance and DSCR (Debt Service Coverage Ratio) loans are two common types of financing used by property investors and developers in the UK. But is it possible to combine these two loan products into one financing package? In this comprehensive guide, we will explore:
- What are bridging loans and DSCR loans?
- The pros and cons of each loan type
- Whether bridging finance and DSCR loans can be combined
- Key considerations when combining these loans
- Tips from finance experts on structuring a combined loan
What Is Bridging Finance?
Bridging finance provides short-term loans, usually lasting 0-12 months, that enable borrowers to “bridge” a financing gap. Common uses of bridging loans include:
- Purchasing a new property before selling an existing one
- Funding renovations or construction projects
- Raising capital quickly for other business purposes
What Are the Advantages of Bridging Loans?
- Speed – Bridging loans can be arranged quickly, sometimes in as little as a few days
- Flexibility – Loan amounts and terms can be tailored to individual needs
- Accessible – Bridging loans may be available to borrowers who don’t meet typical mortgage lending criteria
- Uses – The funds can be used for a wide range of property-related purposes
What Are the Disadvantages of Bridging Loans?
- Expense – Bridging loans typically have higher interest rates and fees than conventional mortgages
- Risk – If alternative financing is not secured by the end of the term, the lender may call in the loan
- Short-term – These loans are not suitable for long-term finance needs
When Might You Use Bridging Finance?
Bridging finance can be useful in situations such as:
- Purchasing an auction property that needs renovations before reselling
- Buying a new home before selling your existing property
- Accessing capital to invest in property development projects
- Securing a property in a short timeframe, such as at an auction
What Are DSCR Loans?
DSCR loans are a type of financing available for commercial real estate investors and developers. DSCR stands for “Debt Service Coverage Ratio”.
How Does a DSCR Loan Work?
With a DSCR loan, the amount you can borrow is based on the property’s projected net operating income (NOI), divided by its annual debt payments.
- For example, if the NOI is £100,000 and the total annual debt payments are £70,000, the DSCR would be 1.4 (£100,000 / £70,000).
- The minimum acceptable DSCR varies by lender but is often 1.20 – 1.25.
- A higher DSCR indicates the property can more easily cover its loan payments.
What Are the Benefits of a DSCR Loan?
- Requires less documentation than conventional commercial loans
- More flexible qualifying criteria, including lower credit score requirements
- Loan amounts up to 85% of the property’s value
- Interest-only payments keep carrying costs low
When Is a DSCR Loan a Good Option?
DSCR loans are ideal for experienced property investors who want to:
- Finance non-owner-occupied properties like apartment buildings or warehouses
- Quickly take advantage of a promising investment opportunity
- Purchase a temporary asset that will be resold within a few years
- Renovate a distressed property before reselling or refinancing
Can You Combine Bridging Finance and DSCR Loans?
Now that we’ve covered the basics of bridging loans and DSCR loans, let’s discuss whether it’s possible to combine them into one financing package.
Is It Possible to Combine Them?
The short answer is yes, it is possible to combine aspects of bridging finance and DSCR loans into one loan. However, there are important factors to consider.
A combined loan would essentially have features of both short-term bridging finance and longer-term DSCR loans. This type of hybrid financing can be attractive for some investors, but may also come with greater complexity.
What Are the Potential Benefits?
Combo loans allow borrowers to tap into the speed and flexibility of bridging finance while also getting a longer repayment term tied to the property’s cash flow.
Specific benefits may include:
- Quick access to capital for time-sensitive deals
- Higher leverage than many banks offer for bridge loans
- Loan terms tailored to your business plan and exit strategy
- Potentially avoiding refinancing at the end of the bridge loan term
What Are the Potential Risks and Drawbacks?
On the other hand, there are good reasons why lenders don’t typically offer hybrid bridging-DSCR loans off the shelf. Combining them requires careful underwriting and aligned incentives.
Possible downsides to combo loans include:
- Complex loan terms and requirements
- Difficulty finding a lender willing to underwrite the hybrid structure
- Higher costs due to the increased risk and specialization
- Less flexibility to change course as circumstances evolve
The decision comes down to whether the benefits outweigh the added complexity for your particular situation.
Key Considerations for Combined Loans
If you think a combo loan may suit your needs, here are some key factors to consider:
Loan Purpose and Exit Strategy
- Why do you need the capital, and what is your end game for repaying the loan? Make sure a hybrid loan aligns with your business plan.
- DSCR loans often have 3-5 year terms. Make sure this timeline works with your exit strategy.
Interest Rates and Fees
- Combing loan types often means higher rates and points. Do the numbers still make sense?
Loan-to-Value (LTV) Ratio
- What loan amount can you qualify for based on the property value and projected income?
Debt Service Coverage Ratio
- Does the property’s stabilized NOI comfortably exceed the required DSCR payments?
- Hybrid loans are best suited to experienced commercial real estate investors. If you’re new, start with a simple product.
Expert Tips on Structuring Combined Loans
For insights on how to successfully structure a combined bridging and DSCR loan, we asked finance experts to share their top tips:
Tip 1: Assess if You Really Need a Combo Loan
Mortgage broker Louise explains: “Many of my clients think they want a combo loan when they really just need either a bridge or DSCR loan. I dig into their goals to see if a blended product is truly the best fit or if a simpler option makes more sense.”
Tip 2: Find an Experienced Commercial Lender
“Not many lenders do combo loans, so finding one with expertise is key,” notes bank VP Brian. “Ask for sample deals they’ve funded successfully. An experienced lender will navigate the added complexity.”
Tip 3: Model Different Scenarios
“Model out scenarios showing how the deal pencils with different loan terms,” advises financier Sam. “Test assumptions like project delays, cost overruns, and interest rate hikes. How much cushion do you have?”
Tip 4: Get Professionals Involved Early
Developer Jenny says: “Engage your full team upfront – lawyer, accountant, broker, etc. They’ll spot issues, provide solutions, and strengthen your loan application.”
Tip 5: Prioritize Clear Terms and Requirements
“Ensure complete clarity on things like timelines, fees, reserves required, guarantor expectations, and so on,” notes lender Priya. “Document everything to avoid misunderstandings later.”
Combining aspects of bridging finance and DSCR loans into one financing package is possible in the UK, but also comes with challenges. The increased costs and complexity may be worthwhile if the combo helps you secure capital and smoothly exit on your desired timeline. But you need an experienced lender, a solid exit plan, and expert advice to make it work.
Assess your specific situation, crunch the numbers, model scenarios, and structure loan terms carefully. For many borrowers, a simple bridging or DSCR loan may meet needs more easily. But for some investors, a tailored combo loan could provide the right funding solution.