Debt Service Coverage Ratio (DSCR) loans are a specialised form of financing used by businesses with stable cash flows. Unlike conventional bank loans that rely on the applicant’s credit score and financial history, DSCR loans focus primarily on the business’ current and future ability to repay debt obligations from its operational income.
While this allows even new companies with limited credit histories to qualify for substantial credit facilities, DSCR loans do come with their own set of requirements and fees – including potentially hefty arrangement fees charged upfront by the lender.
For UK companies seeking to minimise arrangement fees when taking out DSCR loans, this guide covers:
What Are Arrangement Fees on DSCR Loans?
Arrangement fees, also known as facility fees or origination fees, are charges paid to the lender when setting up a new DSCR loan facility.
These fees cover the lender’s administrative costs for underwriting and approving the loan. Items included under arrangement fees are:
- Due diligence on the loan application
- Assessment of the business’ financials and cash flows
- Preparation of the final loan agreement and associated legal documents
- Any external legal fees or valuations required
Arrangement fees are usually quoted as a percentage of the total loan amount. For DSCR loans in the UK, arrangement fees often range from 0.5% to 2.5% depending on the lender and loan size.
So for a £1 million DSCR loan facility, you could expect to pay anything from £5,000 to £25,000 in arrangement fees.
Why Are Arrangement Fees So High on DSCR Loans?
Lenders justify charging substantial arrangement fees on DSCR loans for several reasons:
- Customised Underwriting: Evaluating a company’s future cash flows requires significant upfront work from the lender’s credit team. This is much more labour-intensive than assessing a consumer loan application based on credit scores.
- Bespoke Loan Terms: DSCR loans allow greater flexibility on repayment terms compared to standard business loans. There is effort involved in structuring terms favourable to the borrower’s cash flows.
- ** Higher Risk:** As the lender’s recourse is limited in case of default, DSCR loans are riskier than conventional secured lending against assets. Arrangement fees help cushion this risk.
- Smaller Market: The UK DSCR lending market is still a niche segment. With fewer economies of scale, operational costs tend to be higher per loan transaction.
How Much Are Arrangement Fees on Typical UK DSCR Loans?
To give a sense of the arrangement fees charged in practice, here are some typical ranges for common DSCR loan types in the UK marketplace:
DSCR Bridging Loans
- Typical Loan Amount: £200,000 – £5,000,000
- Typical Arrangement Fee: 1% – 2%
For a £1 million loan: £10,000 – £20,000
DSCR Development Loans
- Typical Loan Amount: £2,000,000 – £15,000,000
- Typical Arrangement Fee: 1.25% – 2%
For a £5 million loan: £62,500 – £100,000
DSCR Term Loans
- Typical Loan Amount: £500,000 – £5,000,000
- Typical Arrangement Fee: 0.75% – 1.5%
For a £2 million loan: £15,000 – £30,000
As evident above, arrangement fees quickly scale into sizable 5-figure sums at higher loan amounts. Minimising these costs can mean major savings for the borrower.
How Can You Negotiate Lower Arrangement Fees on DSCR Loans?
The most direct way to reduce arrangement fees is to negotiate with lenders while shopping for competitive DSCR loan offers.
Here are some tips for negotiating lower fees:
1. Compare Multiple Lenders
- Get proposals from at least 3-4 different DSCR lenders before deciding.
- Use the variance in arrangement fees between lenders as justification to negotiate. For instance, if Lender A quotes 1.5% fees vs Lender B at 1%, you have proof that lower fees are possible.
2. Highlight Factors That Lower Lender Risk
Emphasise strengths in your application that make their job easier:
- Long operating history and stable revenues
- Conservative cash flow projections with ample DSCR buffer
- Hard assets or business premises that can be pledged as additional collateral
- Personal guarantees from company directors
3. Offer Revenue Share Opportunities
Propose opportunities for lenders to earn upside through revenue sharing, such as:
- Profit participation if your project exceeds projections
- Lower fees in return for an equity stake
This incentivises the lender to offer better terms.
4. Limit How Much You Reveal Upfront
Hold back full details of your project plan, financials, partners etc. until the lender provides an indicative offer. This prevents them from maximising fees based on your specifics.
5. Appear Well-Informed on Fee Benchmarks
Cite typical fee ranges for comparable loans and firmly push back if the lender’s quote seems excessive. But avoid revealing your exact minimum acceptable fee level early.
How to Get DSCR Loans With No Arrangement Fees in the UK
While completely avoiding arrangement fees is rare, some scenarios where DSCR loans may come with minimal or no upfront fees include:
If pledging an existing freehold property as collateral, some lenders may be willing to waive arrangement fees and earn their return primarily through interest payments over the loan term.
Invoice Finance Facilities
Rather than lending against cash flows, invoice finance lenders provide an ongoing credit facility against unpaid customer invoices. As setup costs are lower, arrangement fees are often negligible.
Loans From Family Offices
Wealthy individuals making direct investments through their family office or private trust may not charge any formal arrangement fees. However, they may require an above-market interest rate or profit share in return.
Overseas Lenders With Lower Cost Bases
Foreign lenders with back-office operations in lower-cost countries can afford to be more competitive on arrangement fees when entering the UK market.
Loans Against Rental Income Streams
For financing against established rental income from property or equipment leases, some lenders waive fees as cash flows are easier to evaluate.
Ways to Offset Higher Arrangement Fees When Unavoidable
If you are unable to negotiate arrangement fees below 1% or find a fee-free option, here are some ways to reduce the impact:
Look at the Effective Interest Rate
Compare proposals based on the all-in cost of capital over the loan term, not just headline rates. Eg: Paying 2% higher fees but 0.5% lower interest could be cheaper overall.
Roll Fees Into the Loan Amount
Rather than paying fees upfront, ask for them to be added to the loan balance and repaid gradually. This preserves capital for other uses.
Claim Fees Against Taxes
Weigh Against Flexibility Gained
While undesirable, high fees may be justified if the lender offers crucial flexibility like delayed payments, interest-only periods, or lenient refinancing terms.
Use Equity to Bridge the Gap
If required fees exceed budget, consider covering part of the shortfall by bringing in equity partners or subordinated debt at a cheaper cost.
Take a Staged Approach
Start with a smaller pilot facility, then use its success to negotiate better terms when upsizing the loan. Paying full fees on a large single tranche is less efficient.
Does the Loan Term Impact DSCR Arrangement Fees?
Longer-term loans generally attract lower arrangement fees – often by 0.25% to 0.5% compared to short-term facilities.
There are a few reasons behind this:
- Long tenors reflect the lender’s confidence in the business’ stability.
- Longer loans mean greater total interest earned by the lender over time, spreading their risk and setup costs.
- Short-term loans may require multiple refinancings, with fees being paid each time.
The term can make an especially big difference on renewal fees for facilities like revolving credit lines.
How Do Arrangement Fees Vary Between DSCR Loan Types?
Arrangement fees also tend to differ based on the exact DSCR loan product:
DSCR Bridging Loans usually have the highest fees at 2% to 3%, as they carry greater short-term default risk for the lender. Being short-term also means bridging loans cannot amortise setup costs over many years.
Term Loans offer more moderate fees in the 1% to 1.5% range, as they have longer horizons and predictable repayments.
Asset-Backed Loans secured against property or equipment often have negligible fees as low as 0% to 0.5%. The physical collateral provides comfort to lenders.
Trade Finance like invoice discounting facilities charge minimal fees as lending decisions are transactional and automated.
Acquisition Finance sits in the middle with typical arrangement fees of 1% to 2%. Deal complexity raises costs but the sizable lending amounts help dilute them.
Project Finance has slightly elevated fees of 1.5% to 2.5% due to the bespoke analysis required for each development deal.
What Arrangement Fee Structures Should You Look For?
Two final tips when reviewing DSCR loan proposals:
1. Prefer Fees on Drawn Funds Only
Some lenders charge fees upfront on the entire approved facility amount. This forces borrowers to pay for funds they may not fully utilise.
It is preferable to have fees applied only against tranches drawn down over time. Unused credit limits should not incur any charges.
2. Capped Fees Are Better Than open-Ended
Watch for lenders specifying arrangement fees as a wide range like “0.5% to 2%”, rather than a fixed percentage.
Push for written caps on maximum fees payable, to prevent last-minute surprises or inflated charges.
Conclusion: Planning Ahead Is Key To Minimise DSCR Loan Fees
While arrangement fees on DSCR loans can appear dauntingly high, particularly for smaller firms, it is possible to minimise these costs through careful planning:
- Shop around different lenders and negotiate competitively.
- Highlight factors that reduce the lender’s risk and costs.
- Consider longer facility terms and predictable loan types.
- Analyse overall pricing, not just headline rates.
- Offset fees against other savings like lower interest rates.
- Phase larger borrowings across multiple facilities if possible.
With the right loan structure in place, arrangement fees become less of a financial burden. And the operational flexibility from DSCR lending canprove invaluable in turning profitable business visions into reality.