Getting commercial real estate financing can be an expensive endeavor due to high arrangement fees charged by lenders. These fees, which cover administrative costs for underwriting and processing loans, can end up being a significant percentage of the total loan amount. For real estate investors using UK DSCR (debt service coverage ratio) loans, minimizing arrangement fees can help maximize returns and make financing more affordable. This article will explore tips and strategies for reducing arrangement fees when taking out DSCR loans in the UK commercial real estate market.
What Factors Do Lenders Consider When Setting Arrangement Fees For DSCR Loans?
Lenders take various factors into account when determining arrangement fees to charge for a DSCR loan, including:
The Loan Amount
Generally, the higher the loan amount, the higher the arrangement fee. Lenders justify this by saying larger loans require more underwriting work. For loans above £1 million, arrangement fees often exceed 1.5% of the loan amount.
The Loan Term
Shorter-term loans tend to have lower fees than longer-term loans. Lenders consider longer terms higher risk, necessitating more upfront fees.
The Borrower’s Credit Profile
Borrowers with strong credit scores and a history of reliable repayment may pay lower fees than those with poor credit or limited experience, who are deemed higher risk.
The Property Type and Location
Loans for perceived higher-risk properties like hotels or rural land incur higher fees. Also, lenders may hike fees for properties in economically depressed areas.
Competition Between Lenders
When lenders compete for business, they may discount fees to win clients. Less competition means lenders can charge higher arrangement fees.
How Can You Improve Your DSCR to Reduce Fees?
What is a Good DSCR Ratio for Reduced Fees?
Most lenders prefer a minimum DSCR of 1.20 to 1.25. But targets vary by lender. Generally, the higher your DSCR, the lower the fees, as it indicates you can easily handle debt payments. A DSCR above 1.5 signals low risk to lenders and is ideal for reduced fees.
Ways to Improve Your DSCR
You can take several approaches to boost your DSCR before applying for a loan:
- Pay down existing debt – Reducing balances on current mortgages or loans improves your DSCR by decreasing required payments. This shows lenders you can take on more debt.
- Make capital improvements – Upgrades like new rental units or renovations can increase property income, thus increasing the DSCR.
- Raise rents – Within market rates, higher rental income can improve your DSCR.
- Refinance existing debt – If you secure a lower interest rate, your payments decrease, increasing DSCR.
- Extend loan terms – Stretching out mortgage terms lowers monthly payments, boosting DSCR.
- Contribute additional capital – Injecting more of your own cash into the property lowers the LTV ratio, indicating lower risk to lenders.
Proactively enhancing your DSCR displays responsible borrowing and management skill, incentivizing lenders to reduce fees.
How Much Liquidity Should You Have to Reduce Arrangement Fees?
In addition to your DSCR, lenders look at your overall liquidity when setting fees. The more cash reserves and assets you have, the lower your perceived risk.
What is Considered Sufficient Liquidity?
For lowered fees, experts recommend having:
- Enough liquid cash to cover at least 6 months of operating expenses and debt payments for the property.
- Minimal outstanding long-term liabilities like credit card balances.
- At least 15-20% equity in the property.
- Significant reserves of cash and liquid investments separate from the property.
High liquidity indicates you can withstand dips in property cash flow and demonstrates you have “skin in the game”. This gives lenders confidence to reduce arrangement fees.
Ways to Boost Your Liquidity
If your liquidity is lacking, take steps to shore it up before applying for a DSCR loan:
- Build up your cash savings accounts
- Pay down credit card or other debt
- Limit capital expenditure until after securing the loan
- Contribute more of your own cash equity to the property purchase
- Build up emergency funds in safe liquid investments
Increasing liquidity takes time but pays off via lower arrangement fees.
How Can Refinancing or Renegotiating Current Debt Reduce Fees?
If you already have existing mortgages or loans on a property, refinancing or renegotiating terms can be an impactful way to improve DSCR and liquidity to reduce arrangement fees for a new DSCR loan.
Refinancing to a Lower Interest Rate
Refinancing at a lower rate decreases your debt payments, increasing DSCR. This signals to new lenders you can handle extra debt, potentially prompting them to lower arrangement fees.
Extending Your Repayment Term
Stretching out mortgage terms via refinancing lowers monthly payments, improving DSCR. Showing lenders you’ve properly restructured existing debt makes them more likely to discount fees.
Renegotiating with Your Current Lender
If refinancing isn’t an option, you may be able to work with your current lender to modify your existing debt. Extending repayment terms or negotiating lower payments can boost your DSCR without refinancing.
Paying Off Variable Debt
Refinancing variable-rate debt to a fixed rate loan insulates you from future rate spikes that could impact DSCR. Paying off credit cards, lines of credit, or other variable debt also achieves this while boosting liquidity.
Restructuring current debt obligations demonstration savvy borrowing skills and positions you favorably with new lenders to negotiate lower arrangement fees.
Which UK Lenders Typically Offer the Lowest Arrangement Fees on DSCR Loans?
While all lenders charge arrangement fees on DSCR loans, some are more competitive than others on pricing. Here are a few lenders in the UK commercial real estate market that tend to offer lower fees:
Member-owned credit unions focused on specific sectors often aim to provide maximum value. Their fees may be 20-50% less than major banks.
Newer fintech players like OakNorth Bank offer streamlined digital lending with reduced overhead and lower fees to gain market share.
Alternative lenders like commercial real estate firms can offer lower fees than major banks, in exchange for higher interest rates or points.
Foreign banks moving into the UK market sometimes initially discount fees to establish lending portfolios and relationships.
Real estate crowdfunding sites connect investors and borrowers directly, avoiding bank intermediary fees.
Doing some rate shopping among niche and online lenders can uncover arrangement fees up to 1% lower than the big banks, which can mean major savings on larger loans.
How Can You Negotiate with Lenders to Further Reduce Arrangement Fees?
Once you’ve secured the most competitive lender quote possible, you may be able to negotiate directly with the lender to further lower arrangement fees.
Highlight Your Strong Financial Profile
Present details on your DSCR, liquidity, credit rating, and real estate portfolio to showcase your lower risk profile. Emphasize how this justifies reduced fees.
Ask About Discounts for Repeat Borrowers
If you have a lending relationship, inquire about loyalty discounts or fee reductions for repeat borrowers. Make a case for how your history warrants a fee break.
Get Competing Quotes
Leverage rate quotes from other lenders to negotiate. Make a case for how the lender must price match or lose your business. Be ready to follow through with the competitor if needed.
Offer Points, Equity, or Collateral
Bundle Multiple Loans or Products
Lenders may discount fees if you bring other business as well, like getting a revolving line of credit alongside your DSCR loan.
With preparation and negotiation tactics, it’s possible to further chip away at arrangement fees, even after selecting the most competitive lender.
What Are the Other Costs Beyond Arrangement Fees?
When budgeting for a DSCR loan, arrangement fees are just one piece of the puzzle. Be aware of these other typical costs:
- Interest payments – Interest charges accrue over the full loan term, based on the rate and loan amount. Factor payments into cash flow estimates.
- Valuation fees – Lenders often require independent property appraisals to confirm values, at your expense. Budget £3,000-£5,000 for an appraisal.
- Legal fees – Expect to pay around £5,000 for a solicitor to handle loan contracts and paperwork.
- Early repayment charges – If you pay off a loan early, lenders may levy fees equal to a few months’ interest.
- Broker fees – If using a broker, their services may cost 1-2% of the loan amount.
Factor in all these costs to determine if a loan is financially viable and cash flows are sufficient. Avoid surprises by understanding all potential fees.
Final Tips on Minimizing UK DSCR Loan Arrangement Fees?
To recap, follow these tips when seeking to reduce arrangement fees on your next UK commercial real estate DSCR loan:
- Enhance your DSCR as much as possible through increasing income, lowering other debt, and refinancing.
- Build up your liquid cash reserves and equity stake.
- Shop rates from niche lenders and fintech players.
- Negotiate with lenders by highlighting your strong risk profile.
- Weigh arrangement fees vs overall interest rates and costs.
- Don’t neglect other costs like legal fees and valuation fees.
With smart preparation and comparison shopping, reducing arrangement fees is possible – saving major dollars, especially on large loans. Partnering with both an experienced broker and solicitor can provide guidance each step of the process when seeking favorable DSCR loan terms.