HMO properties and mortgage funding

The HMO (houses in multiple occupation) sector is one which has shown significant growth over the last 20 years. A mixture of rising house prices, now out of the reach of many first-time buyers, together with a more mobile employment market have increased demand for HMOs. There is also a very buoyant market in student HMOs where the facilities now available bear little or no resemblance to the stereotypical student accommodation of years gone by. We will now take a look at various issues regarding HMOs, the mortgage market and the five best HMO mortgages on the market today.

Definition of an HMO

Back in October 2018 the UK government adjusted the definition of what are known as large HMOs to bring more properties under the large HMO umbrella, before introducing HMO licences. Prior to October 2018 a large HMO was defined as a property:-

• Occupied by five or more people
• Forming two or more separate households
• Taking in at least three stories

The definition was simplified in October 2018 and is now defined as a property:-

• Occupied by five or more people
• Forming two or more separate households

For reference purposes, a basic HMO (as opposed to a large HMO) is a property:-

• With at least three tenants forming more than one household
• Sharing facilities such as a bathroom and kitchen

At first glance it would appear that HMO licences are targeted towards what are termed “large HMOs” but there is some leeway for local authorities. As a consequence, a number of local authorities across the UK have introduced their own additional definitions to bring smaller HMOs into the fold. These additional properties may also require a form of local licence with both types of licence raising significant revenues for local and national government coffers.

HMO market

When you bear in mind the ever-growing shortfall of newbuilds compared to demand, as well as first-time buyers being priced out of the market, it is no surprise to see significant growth in demand for private rental properties. As a consequence, the combined value of student HMOs and professional HMOs in the UK now tops £20 billion. The following graph illustrates the changing trends between homeownership and the private/social rental market.

Households by tenure 2007 to 2017

Households by tenure 2007 to 2017
It is also worth noting the changing demographics, such as those aged between 16 and 24 living longer with their parents, highlighted in the following graph:-

Private renting sector by age of household reference person between 2007/17

Private renting sector by age of household reference person between 2007/17

The opportunity to create double-digit rental yields has seen a number of corporate entities entering the HMO market. This has prompted concerns that the UK government would prefer corporate entities to control the sector. These fears would appear to be confirmed with increased costs and the watering down/revoking of a number of personal tax benefits for private landlords. These include:-

• A 3% stamp duty surcharge on second home acquisitions
• The replacement of mortgage interest relief by a flat 20% basic tax allowance
• Adjustments to allowable wear and tear tax deductions
• More expansive tenant rights

Interestingly, the impact of these tax changes is dramatically reduced if HMOs are acquired within a company structure. This would seem to confirm initial concerns that relatively small sized private landlords operating in the HMO market will find it more difficult going forward.

HMO mortgage market

The HMO mortgage market is very different to the traditional mortgage market with lenders often erring on the side of caution with regards to deposits, LTV ratios and interest cover. For example:-

Deposit/LTV ratio

Unless approaching specialist buy-to-let mortgage lenders the minimum deposit required is likely to be no less than 25% which equates to a maximum LTV ratio of 75%. Indeed, some mortgage companies will demand a 40% deposit with a 60% LTV ratio. Some properties may also require additional finance to convert the building into an HMO which landlords may need to fund themselves.

Interest cover/rental cover rate

A typical HMO/buy-to-let mortgage stress test will incorporate an interest cover ratio of between 3.5% and 5.5% (effectively an assumed mortgage interest rate) with rental cover between 125% and 145%. As a consequence, if we assume a 5.5% interest cover ratio and rental cover of 145% the figures on a £200,000 HMO mortgage would be as follows:-

Loan amount £200,000 x Income cover ratio 5.5% = Annual interest £11,000

However, using a 145% rental cover rate the minimum annual rental income on the property would need to be:-

145% x Annual interest £11,000 = £15,950 per annum or £1,329 per month

If we assume that the mortgage finance of £200,000 represents a 75% LTV ratio then the property would be worth £266,666. In order to create rental income of £15,950 per annum an HMO rental yield of 6% would be required. While it is possible to secure double-digit yields on some HMO properties even if we take the average of just over 7% this would offer some headroom on the 6% requirement above.

Investment experience

In theory the administration of an HMO is fairly simple, find tenants, secure contracts and create a long-term income stream. However, there are various issues to consider such as:-

• Rent arrears
• Income shortfall between tenancies
• Legal costs
• Costs such as HMO licences
• Potential HMO conversion costs

As a consequence, many buy-to-let mortgage lenders would prefer clients to own their own property and have experience in the HMO/buy-to-let market. This is one of the reasons why there is such large headroom between the required deposit and LTV ratio – compared to some owner occupier mortgages.

Self-employed landlords

It can be difficult for self-employed landlords to secure buy-to-let mortgage funding unless they are able to show at least two years of positive accounts. This in itself can create a problem because accounting to reduce personal tax liabilities reduces net income. When applying for a buy-to-let mortgage it would be helpful to quote the highest net income possible. This is the age-old quandary for the self-employed looking to raise mortgage finance.

Age of landlord

You might have been forgiven for thinking that experienced landlords would be seen as less of a risk than those fairly new to the HMO market. In theory this is correct but mature landlords above 60 years of age may find it difficult to secure finance. As a consequence of their age, and perhaps reduced income, they are often seen as a considered risk. That said there are now specialist buy-to-let mortgage providers who will look at the overall picture of a mature landlord and take into account their income and assets.

Potential tenants, family and friends

Interestingly, when overseas investors acquire second homes in the UK, mortgage companies prefer family members/friends to reside there if the owner is unable to. This offers a degree of security and ensures that the property will be kept in good order. The situation is turned on its head when it comes to HMO/buy-to-let mortgage finance. Many mortgage companies will reject applications where family or friends will be living in the rented accommodation. In many ways this is a simple scenario where mixing business and pleasure may not always be as straightforward as hoped.

Specialist HMO/buy-to-let mortgages

As we touched on above, the traditional HMO/buy to let mortgage market can be fairly restrictive with regards to deposits and LTV ratios. As an independent mortgage broker, Enness has access to more than 300 lenders across financial markets. Many of our specialist mortgage contacts tend to be more appreciative of additional assets and income streams allowing us to negotiate competitive rates. As a consequence of the added risk associated with HMO/buy to let properties, mortgage rates tend to be higher than those for homeowner mortgages but this is not always the case.

A number of specialist HMO mortgage providers are keen to accommodate assets under management (AUM) arrangements and build long-term relationships with clients. An AUM arrangement offers an additional insurance policy/headroom between the level of finance, property value and security, providing scope for competitive introductory mortgage rates. When you also consider that UK base rates are near their historic lows there are some attractive short to medium term fixed rates available.


While some areas of the UK HMO market may be seen as saturated, there are still numerous opportunities out there to acquire/convert relatively large buildings into large HMOs. While there will be additional costs to redevelop some buildings the opportunity to create HMOs with double-digit rental yields is attractive. University cities across the UK such as Birmingham, Manchester, Liverpool and Leeds are now benefiting from not only demand for student accommodation but also high graduate retention numbers, creating additional demand for professional HMO accommodation.

Over the last few years we have seen a number of regulatory/tax changes which have impacted the buy to let market. Therefore, for those looking to build up a significant HMO portfolio it may be worthwhile taking advice on whether to adopt a corporate structure or retain a personal investment approach. Suspicions that the UK government would prefer the HMO market to be led by corporate entities with larger portfolios seem well-founded. Recent regulatory/tax changes have made it more difficult to secure acceptable returns on relatively small portfolios. Therefore, we are likely to see larger HMO portfolios going forward with increased cash flow and economies of scale.

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