What is an HMO Mortgage?
An HMO (House in Multiple Occupation) mortgage is a unique type of buy-to-let mortgage aimed at tenants renting individual rooms in a house. These are rented by three tenants or more, with larger HMOs – those occupied by at least five tenants – typically facing tougher rules. It’s essential to know what HMO mortgages actually entail for investors, as they’re not the same animal as a typical buy-to-let.
The Core Definition
An HMO mortgage enables landlords to buy properties with the goal of housing tenants from different households. These tenants will share facilities such as kitchens, bathrooms or living rooms. Properties that have five or more tenants are most commonly considered large HMOs and typically need more complicated licences from local councils. These licences, of up to five years’ duration, are necessary to ensure adherence to health, safety and welfare standards. For landlords, the licensing process is vital to remaining on the right side of the law.
The Key Difference
Unlike mainstream buy-to-let mortgages, HMO mortgages will have to cover several tenancies in one property. This makes HMO mortgages less popular amongst lenders and leads those that do offer them to set tougher eligibility rules. For instance, lenders usually expect landlords to show greater rental income margins, generally between 25% and 45% over the monthly mortgage payment when worked out using stressed rates. Any property with more than five bedrooms may be beyond conventional HMO mortgage terms, turning to commercial financing.
The Lender’s View
From a lender’s perspective, HMO properties are riskier since they have multiple tenants and increased wear and tear. Consequently, lenders might impose lower loan-to-value (LTV) ratios – typically around 75%, although some will offer 80%. They prefer certain types of properties and tenants, so landlords need to research lender preferences closely. The high level of difficulty involved in administering multiple tenancies is a reason why lenders consider HMO mortgages less readily available than standard ones.
The Investor’s Advantage
For landlords, HMOs can offer higher yields than a conventional buy-to-lets, with multiple tenants making up the income. These advantages carry additional burdens, such as securing and renewing HMO licences, maintaining property standards, and juggling tenant turnover. The opportunity for greater cash flow means HMO investments are an appealing option for seasoned investors who are prepared to tackle the challenges that come with them.
Lender’s HMO Criteria
Lenders offering buy-to-let mortgages for Houses in Multiple Occupation (HMOs) evaluate applications based on specific criteria. These factors help assess the borrower’s suitability and the property’s potential to generate sufficient income. Understanding these requirements is essential for navigating the application process successfully.
Your Experience
Lenders favour borrowers with previous property management or buy-to-let experience, particularly for HMOs because they’re complex beasts. Running an HMO tends to mean coping with more tenants and adherence to tighter rules. So, if you’ve successfully run single-let properties or smaller HMOs in the past, this will bolster your application.
Some lenders will consider first-time landlords, especially if they can show that they clearly understand their responsibilities. In such instances, collaborating with a professional managing agent could be beneficial. Make sure to reference your experience or preparation when applying for an HMO mortgage.
Your Income
How much you earn is important but lenders tend to be more lenient with HMOs than traditional buy-to-let mortgages. A handful of lenders don’t have minimum income requirements, concentrating on the property’s rental income instead. Normally, they want the rent to be 125% -145% of the monthly mortgage to make sure it is affordable.
So your monthly mortgage payment is £800, the rent ought to be anything from £1,000 to £1,160 or more. This additional risk of HMOs is reflected in their higher limit. A property minimum valuation of £100,000 (£250,000 in London) is commonplace, to make sure the market value of the property aligns with the loan amount.
Your Portfolio
Your existing property portfolio Borrowers with multiple properties can expect further scrutiny, as lenders evaluate their overall financial position. So, for example, if you own three properties with mortgages still on them, this can affect the lender.
Portfolio size can influence rate or terms. Lenders prefer borrowers with more modest, well-managed portfolios – it indicates a lower risk. If you have a bigger portfolio, keeping impeccable records and showing solid rental income streams can alleviate worries though.
Financial Implications
When looking into a buy-to-let mortgage for an HMO (House in Multiple Occupation), knowing the financial side of things is key. These mortgages have specific requirements and costs compared to regular buy-to-let loans, given the complexity and risks of operating an HMO property.
Higher Deposits
HMO mortgages are often more stringent when it comes to deposits than standard buy-to-let mortgages. Although it may be acceptable to pay a deposit of at least 15% of the property’s value in some cases, lenders typically anticipate larger contributions – 20% or more isn’t unusual. That’s because of the extra risk of dealing with more tenants and the possibility of longer voids. Take a £400,000 HMO property, for example, where the 15% deposit works out at £60,000, compared to £100,000 for a 25% deposit. Borrowers need to budget accordingly for this increased immediate cost.
Interest Rates
Interest rates on HMO mortgages are usually pricier than standard buy-to-let deals. This is indicative of the greater risk lenders associate with HMOs, which can require more management and experience more turnover of tenants. Monthly repayments will be based on these rates and if the house isn’t remortgaged at the end of the introductory rate period, payments could rise dramatically because of the lender’s reversion rate. For example, a 4.5% fixed rate could become 6% or higher. Borrowers will need to consider these potential increases when planning their long-term costs.
Arrangement Fees
Arrangment fees for HMO mortgages are usually higher than for regular buy-to-let loans. These account for the broker and legal fees involved in arranging the mortgage and can be between £1,000 and £3,000 or so. Some lenders take a cut of the loan amount, which adds to the cost. For a £300,000 loan a 1% arrangement fee would add £3,000. Comparison of lenders’ fee structures is important in order to keep cash outlay to a minimum.
Rental Stress Tests
Lenders employ rental stress tests to determine affordability. Usually, rent has to cover 125%-145% of the monthly mortgage payment, to ensure the property is still financially viable during void periods or rent collection problems. If your mortgage payment is £1,000, your anticipated rental income might need to be £1,450. Some lenders will use a stressed interest rate, demanding 25% to 45% more rent than the mortgage payment itself to account for market turbulence. This is what makes HMOs appealing, as their rental yields can be significantly higher than traditional buy-to-lets – £45,600 a year for a 4-bed HMO versus £30,000 for a conventional buy-to-let, to give one example.
The HMO Property Itself
So, what does your HMO (House in Multiple Occupation) need to offer for a buy-to-let mortgage? Usually rented to three or more people from different households, these properties share communal facilities such as bathrooms or kitchens. Achieving the specific requirements of an HMO can affect a property’s design as well as the mortgage.
Property Type
There are many different types of HMO property, which gives landlords options. Typically, these are terraced, semi-detached or detached houses. Bigger properties such as small flats, old hotels or care homes are converted to accommodate multiple tenants. Converting a normal property to an HMO usually requires extensive remodelling. This can mean anything from putting in additional bedrooms to creating shared spaces. For instance, landlords might have to put in fire doors everywhere or provide sufficient kitchen space and facilities. These refurbishments are labour-intensive and frequently need to be carried out while the property is empty, delaying rental income.
Room Count
A property must have at least three bedrooms to be considered an HMO. Each room must be a certain size to accommodate tenants and maintain adherence to local housing standards. In bigger HMOs, more facilities are required. For example, a property with five tenants needs a cooker with four hob rings, an oven and a grill. These conditions not only determine the configuration and purpose of the property but the budget for refurbishments. For landlords, the trick to enticing tenants and maximising potential rental income is ensuring enough bedrooms and shared spaces.
Licencing Rules
In England and Wales, what are known as large HMOs - usually, that is, those with five or more tenants - have to be licensed by the local authority. Licensing includes inspection for safety and compliance, including fire alarms and space standards. Other rules vary by council, so landlords should check local requirements. Without the appropriate license, landlords face fines or trouble getting a mortgage. Making sure you’re compliant early could save you time, hassle and money when it comes to renting.
Navigating the Application
How to apply for a buy-to-let HMO mortgage Knowing how it works can make for a smoother experience that meets lender criteria.
Documentation
First and foremost, lenders often demand proof of financial stability. This means income (usually at least £25,000 a year), employment and your deposit’s source of funds. For first-time buyers or landlords, this paperwork could be more extensive, as lenders frequently require larger deposits, sometimes as high as 40% of the property’s value. More experienced landlords will see this threshold lower still – deposits starting at 15%.
Applicants must also prove the property’s rentabiltiy. Lenders want the anticipated rental income to pay for 125% to 145% of the monthly mortgage payment, so that it’s affordable for the borrower. Bear in mind, local authorities may need you to have an HMO license, particularly for bigger buildings. This license proves the property meets safety and quality standards, which is frequently a condition of final mortgage approval.
Broker Choice
A mortgage broker can make the application process easier. Brokers have invaluable market insight and can find lenders that fit your situation, whether you’re an aspiring landlord or a seasoned pro. Some lenders only deal with brokers so their products aren’t available to borrowers directly.
Some brokers only do high LTV (loan-to-value) mortgages, which are helpful when seeking the greatest borrowing capacity. Others might concentrate on lenders prepared to accept a lack of landlord experience. A broker’s experience steers through this, saving time and possibly getting you a better deal.
Valuation Process
The valuation process guarantees the property is a good investment. Lenders require an independent valuation to verify the value and rental potential of the property. This is vital for HMOs, as lenders check how the property is laid out and how many people live there.
For example, a multi-bedroom property would likely face intensification of analysis because of higher rental yields. Valuation influences your LTV ratio, the percentage of your property value you can borrow against. Houses with better rental yields are typically more attractive, but ultimately it’s the lender’s rules that will decide.
Future-Proofing Your HMO Investment
How do you make sure that your HMO investment is sustainable and profitable? From regulation to new tenant expectations, there’s plenty to think about when it comes to protecting your portfolio’s future.
Article 4 Areas
Local authorities across the UK are becoming more and more strategic with Article 4 Directions. These regulations strip away permitted development rights, which means landlords now need full planning permission for HMO conversions in selected locations. For example, Nottingham and Manchester have implemented such a policy to control housing density and quality. This makes it vital to investigate local policies prior to purchasing a property.
Investors should be geographically diverse. The flexibility of owning HMOs in non-Article 4 areas can limit the risks associated with localised policy changes. For instance, mixing properties in stricter zones with those in milder areas can balance your portfolio.
Evolving Standards
The HMO model has changed a lot in the last few years. Contemporary HMOs can provide high-spec, well-kept accommodation that attracts a wider audience, such as young professionals and key workers. This shift occurs against the backdrop of a housing shortage in the UK (demand for affordable shared accommodation is soaring).
In order to remain competitive landlords have to meet stricter requirements for safety and quality. This means fulfilling legal licensing requirements, electrical safety, and offering sufficient communal areas. For instance, bringing old houses up to date with en-suite bathrooms or sound-proofing can entice long-term tenants and command premium rents.
Lenders review rental income in relation to mortgage payments. Most need 45% more rental income than stressed monthly mortgage payment, making efficiency and profitability crucial.
Tenant Demands
Knowing your tenant’s requirements is key to a durable HMO. Tenant preferences really do differ, with some favouring price and others favouring convenience and amenities. For example, young professionals typically look for homes with good transport links and modern furnishings.
Good management is key too. Without systems or a trustworthy letting agent in place, juggling multiple tenants can get out of hand. This is all the more important because lenders may consider whether a property’s operations are strong enough to qualify for funding.