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Richard from Rose Capital talks us through HMO mortgages.
What is an HMO mortgage?
This is probably the most complicated area of Buy to Let. There’s a lot to talk about but keeping this as simple as possible, there are two types of HMO. You might be letting a single property to more than one person. For example, you might own a three bedroom house and rent out each room separately – that would trigger HMO rules.
What makes it complicated is that every local authority in the country has slightly different rules. Many of them define an HMO as having five or six bedrooms. So even if it’s not sublet, it could still be deemed an HMO, which means you need to get special licensing – which we’ll expand upon.
So what we’re going to talk about today is a house that’s split into multiple units, or a large house. That’s the simplest way to define what an HMO is.
What are the different types of HMO mortgage?
Again, this splits into a number of areas. This is fundamentally a Buy to Let. So if you’re familiar with the Buy to Let market, it’s all the same choices. You can have a fixed rate, a variable rate, you can set up a repayment mortgage or interest only. 99% of mortgages all work that way.
However, there are a couple of key differences to pull out. HMO is more for experienced investors, and you might find that lenders have criteria around you having a certain level of experience.
We do get more professional investors who buy through limited companies which is fine. We tend not just to look at the HMO itself – there might be a background portfolio to talk about. Again, that’s a big topic but I’m not going to get into it. Some banks look at the wider portfolio and some don’t.
We do deal with clients with 20, 30 or 40 properties. But the product choice is the same, the regulations are the same and the assessment part we will come on to later.
Who can get an HMO mortgage?
As I alluded to, there are a couple of rules around this now. This isn’t specific, but as general guidance, most HMO mortgage providers want you to be an experienced landlord. That means you’ve owned a rental property for a year or more – it’s not like you need to have done it for 20 years.
Typically you need to be a homeowner yourself – but again not all banks insist on those two requirements. The other one is the level of deposit. This does change over time, but the rule of thumb is that you need a 25% deposit on the property you’re looking at buying.
If you can tick those three boxes you have your choice of most of the lenders in the sector. If you can’t tick one or more of those boxes, it can get a bit harder to get a mortgage.
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When would you use an HMO mortgage?
Again, it comes back to the definition. You would need one if you’ve got a property that’s let room by room, which is what we most commonly see. We’re predominantly based in London and there are lots of big houses that are split up.
But we also get a lot of high value transactions that trip into this world. Say you own a £4 million pound house in southwest London or prime central London with lots of bedrooms, you trip into this because it’s around the number of bedrooms and the local authority’s definition of whether that’s an HMO or not.
The number one factor, though, is having different tenancy agreements for the people in a property at one time.
Are student properties HMOs?
Great example. Let’s say for example, four student friends move into a four-bedroom house but sign one tenancy agreement. That may not be an HMO. However, if you’re renting a room within a larger property with separate locks on your doors, and your contract is separate from your friend’s even though you moved in at the same time, that definitely would be an HMO.
That’s actually a really good example of the greyness of this area. It depends on the structure of the tenancy and structure of the property.
I’ve got one client who does accommodation for a living and owns a big block of purpose built flats with shared access and shared amenities. That is by default an HMO. But people often don’t classify student accommodation as an HMO – but they are essentially the same thing.
How would I arrange an HMO mortgage?
That’s our job. By virtue of being a broker and one of the more experienced people in this sector, we have access to products and lenders that you wouldn’t get directly. Some of them just do not deal with the public.
On a more practical level, we’ll make sure you meet all the qualifying criteria mentioned previously about experience, deposit etc. We’ll also go through the ICR calculation – that’s interest cover ratio. If you were a landlord prior to about 2007 this used to be really simple. If your rent exceeded your mortgage by 125%, the bank was happy.
These days, like everything, it’s not so simple. We’ve just come out of an ultra-low interest rate environment [podcast recorded May 2023] and banks ignore the rate you’re charged on the mortgage and assume a higher rate of something like 5.5%. They then apply that ICR of about 145% on top of that figure.
How that works in numbers is if you borrowed say £100,000 at 5%, that works out to be £416 a month. If you increase that by 145% it’s £604 a month. So if you wanted to borrow a million pounds, for example, the rent would need to be about £6040 a month and you can scale that up and down as you need. So that’s a rough finger in the air. The ICR is to cover things like future interest rate movements, tax, maintenance.
The market as we speak today is in a bit of flux around that first calculation because the stress test was there to safeguard against interest rates rising. Some banks are actually pushing that a bit higher. The good thing about HMOs is that these tend to be very high yielding properties and there’s normally ample income to make it work.
How are HMO mortgages different from Buy to Let mortgages?
One thing we haven’t expanded on is the licence requirement. As I touched on, local authorities all have different processes. I’ve often lived around Wandsworth and their website is brilliant. You jump online and the search result comes up pretty quickly.
There’s normally an application form and a fee to pay. There are detailed criteria around this and as with the whole sector at the moment there are lots of rules around energy efficiency. There are also general standards around maintenance of the property, so they’re not just given out.
There is sometimes a survey, and you have to sort of self-declare a lot of information. Your local authority may want to visit. The licence can cost £1,000 to £2,000 and it normally lasts about a year or so.
Also, particularly when you’re buying, a bank will want all this in place. If you don’t have your licence or if the local authority is unhappy, you will not get a mortgage. These two things do go hand in hand so it’s worth exploring that as part of the mortgage process.
Is there anything else to consider with HMO mortgages?
These are high yielding properties, but multiple room lets does involve a lot more work. That’s why lenders seek professional landlords rather than someone who’s just getting into this space. But the rewards are absolutely there, as long as you keep up with licensing rules.
Where our clients tend to fit into this space is that it really works around affordable housing for people who maybe couldn’t afford to rent a property on their own. There are a lot of really professional people coming into this space and setting up good properties of an excellent standard. Historically there’s been a bit of a bad reputation toward it, but the licensing regime has really cleared up a lot of that which is positive.
In social housing and affordable housing it’s closing a gap where the government hasn’t focused for a very long time. As we talk today this is a problem that’s always got worse. There is not enough rental stock and around London it’s even more acute than anywhere else. So there’s a real opportunity for people to give really good quality housing to people at the lower end of the spectrum, and when done correctly this is a hugely positive thing.
Just to reiterate one important thing – this is very complicated. There’s not just the mortgage to take care of – which is complicated in itself. You’ve got the local authority to work with and this might be part of a larger portfolio. It might be through your limited company and there are different rules around that as well.
That’s why it’s really beneficial to have someone like us on board who knows what’s required. Really early on we’ll ask whether you have done certain things in the right order – because there’s no point paying survey fees and application fees for it all to go on hold down to a little thing we could have dealt with at the start.
We make sure you know what’s happening throughout this application. We do get lots of exclusive products and access to banks that don’t deal with the public – and we also have other avenues available. The commercial arms of high street lenders are really into this area. There’s lots of things you just wouldn’t have access to unless you deal with a broker like ourselves.
Your property may be repossessed if you do not keep up with your mortgage repayments.
Most Buy-to-Let Mortgages are not regulated by the Financial Conduct Authority.