Debt Service Coverage Ratio (DSCR) loans are a popular financing option for real estate investors in the UK. These loans are available at both fixed and variable interest rates. So how do you decide whether a fixed or variable rate DSCR loan is better for your investment property financing needs? This comprehensive guide examines the key differences, pros and cons, and factors to consider when weighing up fixed vs variable rate DSCR loans in the UK.
What Is A DSCR Loan?
A DSCR loan, also known as a rental or income property loan, is a type of financing used by real estate investors to purchase or refinance investment properties meant for renting out.
Lenders assess a property’s ability to service debt payments by looking at its Debt Service Coverage Ratio (DSCR). This ratio compares the property’s annual net operating income to its total annual debt obligations.
To qualify for a DSCR loan, the property’s DSCR must be at 1.25 or higher. This indicates the property generates enough rental income to cover 125% or more of its mortgage payments and expenses. A higher DSCR is preferable as it means more rental income is available to service the debt.
How Do Fixed And Variable Rate DSCR Loans Differ?
The main difference between fixed and variable rate DSCR loans relates to how the interest rate is determined:
- Fixed rate DSCR loans have an interest rate that remains the same for the entire loan term, such as 5 or 10 years. Your monthly payments do not fluctuate.
- Variable rate DSCR loans have an interest rate that can go up or down during the loan term, depending on market conditions. Your monthly payments can fluctuate accordingly.
The initial interest rate is typically lower for a variable rate loan. But there is a risk the payments may increase significantly if rates spike upwards.
Fixed rate loans provide certainty – you know exactly what your monthly payments will be. But you may miss out on decreases in variable rates.
Below is a comparison of some key features:
|Fixed Rate DSCR Loan
|Variable Rate DSCR Loan
|Stays the same through the full term
|Can fluctuate up or down
|Do not change
|Can go up or down
|Usually 5, 7 or 10 years
|Typically 3-5 years
|Initial Interest Rate
|Rate After Initial Term
|Must be refinanced
|Automatically switches to variable
What Are The Pros And Cons Of Each Type?
Fixed rate DSCR loans provide stability and predictability for the duration of the loan, making budgeting and cash flow planning simpler. However, you may miss out on decreases in market interest rates.
- Interest rate remains the same for full term
- Monthly payments do not change
- Easy budgeting and cash flow planning
- Avoid payment shock from rising variable rates
- Higher initial interest rate
- Miss out if rates fall
- Prepayment penalties if refinancing
Variable rate DSCR loans offer lower initial rates but carry the risk of rising payments if rates increase. You can benefit from decreases in market rates.
- Lower initial interest rate
- Benefit from decreases in market rates
- Lower prepayment penalties
- Payments can rise significantly
- Harder to predict payments long-term
- Budgeting/cash flow planning more difficult
What Factors Should You Consider For Fixed vs Variable DSCR Loans?
Determining whether to opt for a fixed or variable rate DSCR loan depends on your unique situation and perspective. Key factors to weigh up include:
What Is Your View On Interest Rate Movements?
- If you expect rates to rise significantly in the near future, a fixed rate protects you from higher payments
- If you anticipate rates falling, a variable rate allows you to take advantage
Consider expert forecasts on interest rate trends and make the best prediction you can.
How Strong Is Your Current Financial Position?
- If your income is stable and robust, variable rate risk may be manageable
- If your income fluctuates, a fixed rate provides vital payment certainty
Evaluate your current and projected financial strength. Be conservative if any uncertainty.
How Do You Prefer To Budget And Plan Finances?
- If you like to budget precisely, fixed payments will suit you better
- If you have flexibility to absorb fluctuating costs, variable rates may work
Think about your preferences for managing cash flow and expenses.
How Long Do You Plan To Hold The Mortgage?
- Short term: A lower variable rate may save more on interest
- Medium term: Weigh rate trends and budget needs
- Long term: A fixed rate can provide longer stability
Match the rate type to your planned investment time horizon.
Do You Have A Large Down Payment?
- More equity lowers risk if rates increase with a variable loan
- Less equity makes fixed rates more appealing
The size of your down payment can impact your perspective.
What Are The DSCR Loan Rates Being Offered?
- Compare fixed vs variable rate options from multiple lenders
- Assess if the rate difference merits the variability
Shop around to find the most appealing rates before deciding.
Finding The Best Fixed And Variable Rate DSCR Loan Deals
Where can real estate investors find the best DSCR mortgage rates in the UK today? Here are some tips for securing a competitive fixed or variable rate loan:
- Comparison sites: Check aggregators like MoneySuperMarket and GoCompare to contrast rates from multiple lenders at once.
- Mortgage brokers: An experienced broker can access DSCR loans from a wide panel of lending sources and find you the best deal based on your situation. Make sure they are familiar with securing finance for investment properties.
- Direct commercial lenders: Some non-bank commercial lenders focus specifically on financing investment properties through DSCR loans. They may offer more flexibility than high street banks.
- Banks: Major banks like Lloyds, HSBC and Barclays may also offer DSCR loans or business mortgages suitable for investors.
- Peer-to-peer lending: Newer P2P platforms like LendInvest provide an alternative way to borrow from individuals rather than banks.
- Portfolio landlords: Large portfolio landlords with 10+ properties may get better DSCR rates based on their substantial lending business.
Shopping around and comparing DSCR loans on both a fixed and variable basis can potentially save you thousands. Rates and terms vary, so take time to find the best option.
Should I Fix My DSCR Loan For The Full Term?
While DSCR lenders often allow you to fix your interest rate for the full loan term (e.g. 5 years), doing this may not always be the best strategy.
Some points to consider:
- Future refinancing – By fixing for the full term, you lose flexibility to refinance if rates drop in the future. You may be stuck paying a higher fixed rate.
- Shorter fixed periods – A lower 2 or 3 year fixed rate period gives you flexibility to remortgage sooner if rates fall. This can limit your fixed rate risk exposure.
- Rate trends – If you expect interest rates to drop significantly in the next few years, limiting your fixed rate term gives you the option to take advantage and refinance at a better variable or fixed rate later.
- Early repayment charges – The lender may charge expensive early repayment fees if you want to refinance before the fixed term ends. Shorter fixed terms limit this penalty risk.
- Your plans – Consider your investment horizon. If you may sell the property within a few years, a shorter fixed term may suit you better than fixing for the full mortgage term.
Should I Take A Tracker Or Discount DSCR Loan?
Tracker and discounted variable rate mortgages are two popular types of variable rate DSCR loans in the UK. Which one is better for you?
How Do They Differ?
- Tracker mortgages – Your interest rate tracks the Bank of England base rate at a set margin above it. When the base rate rises or falls, your payments follow accordingly.
- Discounted mortgages – You get a variable rate set at a discount to the lender’s standard variable rate (SVR). If their SVR goes up, your rate and payments also increase.
- Trackers are more directly influenced by Bank of England rates. Discounted mortgages follow the lender’s own SVR, which may not match base rate movements.
Factors To Consider:
- Future base rate forecasts – If you expect base rates will rise significantly, a discounted mortgage protects you somewhat from increases tied directly to base rate.
- Lender SVR reputation – Research how frequently your lender raises their SVR when base rates are static. Frequent raises indicate a discounted variable from them may cost more long-term.
- Discounted margin – The lower the margin discount you qualify for, the more protection you get if the lender’s SVR rises.
- Risk appetite – Trackers have greater interest rate uncertainty as you are exposed directly to base rate changes. Discounted variable loans have slightly less volatility.
- Rate tracking – Discounted mortgages may not track very low Bank of England base rates. This matters less currently with the base rate so low already.
How Much Financing Do I Need For A UK Investment Property?
Purchasing an investment property in the UK using a DSCR loan typically requires at least a 25% down payment from you as the buyer. Here is an overview of the key costs to factor into your financing needs:
Most lenders want at least 25% as a down payment or deposit. This provides enough equity cushion in case property values dip.
With £200,000 purchase price, you need around £50,000 minimum for the down payment.
- Using the £200,000 example, if you put 25% down, you need a £150,000 mortgage.
- Plus approximately £2,000 in mortgage fees to the lender.
Have funds reserved for any renovations or repairs needed to optimise rentability. Budget around £5,000 – £10,000.
What Happens When My Fixed Rate DSCR Loan Period Ends?
If you have opted for a 2, 3 or 5 year fixed rate deal, what happens when your fixed rate period comes to an end? You effectively have two main options:
1. Remortgage To a New Fixed Or Variable Deal
- You can remortgage and negotiate a new DSCR loan deal entirely.
- This gives you flexibility to find the best new rate.
- Make sure your property still meets minimum DSCR requirements.
- Beware expensive early repayment charges if still in your fixed rate period.
2. Automatically Switch To Your Lender’s Standard Variable Rate
- Your mortgage will switch to your existing lender’s variable rate.
- This provides continuity but may be a more expensive rate.
- Make overpayments during the fixed period to lower the mortgage amount before it switches.
- Check for better variable rate deals available if you stay with your existing lender.
It’s advisable to discuss remortgaging options with your broker 4-6 months before your fixed term expires. This gives you time to find the most suitable new deal.
Can I Get A Fixed Rate DSCR Loan For 10 Years?
While most fixed rate deals run 2-5 years, some lenders do offer longer 10 year fixed rate periods for DSCR loans.
Benefits Of 10 Year Fixed Rates
- Certainty of payments for a whole decade.
- Avoid expensive early repayment charges for 10 years.
- Insulated from any interest rate rises during that period.
- You lose flexibility to take advantage if rates fall.
- Financial situation less considered over 10 years – income may rise.
- Lender may impose prepayment penalties if you want to refinance.
Who 10 Year Deals Suit
Longer fixed rates can provide stability for:
- Investors prioritising cash flow predictability.
- Those worried about rising interest rates over the next decade.
- Investors planning to hold the property long-term.
Speak to your broker about availability, prepayment terms, and compare costs of 5 year vs 10 year fixed rate DSCR loan options.
Final Tips For Securing The Best UK DSCR Mortgage
Here are some final tips when applying for the most competitive DSCR loan deal for your investment property:
- Provide as much documentation as possible to show strong rental demand and healthy projected DSCR.
- Get your property appraised to confirm its current accurate market value.
- Highlight experience managing other investment properties.
- Have reliable agents or a property manager arranged to handle rentals.
- Look for lenders that specialise in financing properties solely for investment purposes.
- Emphasise the amount of equity you are putting down to lower risk.
- If your credit score is limited, offer to put down an even larger down payment.
- Check for first-time investor mortgage deals and commercial loan products.
- Explain exit strategy and highlight that the loan will be relatively short term.
Taking these steps lets you present yourself as a lower risk investment property borrower, enhancing your chances of DSCR loan approval on agreeable terms.