HMO mortgages: financing a house of multiple occupation

An HMO mortgage is a specialist buy-to-let mortgage for a property let room by room to people from separate households. Expect at least a 25 per cent deposit, a much smaller lender panel than standard buy-to-let, and criteria that look at your landlord experience, the number of lettable rooms and the property licence. Rents per room are higher and yields can be strong, but valuation, licensing and management are all harder work than a single let.

Broadly, a property is a house in multiple occupation when at least three people from more than one household live there and share a kitchen, bathroom or toilet. A licence is a separate question from whether the property is an HMO.

In England and Wales a mandatory HMO licence is required where the property is let to five or more people forming two or more households who share facilities. Below that threshold, many councils operate additional licensing schemes covering smaller HMOs, and some run selective licensing that can catch ordinary single lets as well. Schemes are introduced and renewed locally, so check with the specific local authority before you buy rather than relying on what applied in the next borough. Scotland and Northern Ireland run their own HMO licensing regimes with their own thresholds and processes.

Licensing is not a formality. Expect conditions on room sizes, fire doors and alarm systems, kitchen and bathroom provision per occupant, and amenity standards. Lenders increasingly want to see either a licence in place or clear evidence that one will be granted.

There is a second layer that catches people out. Converting a family home into a small HMO for up to six people is often permitted development in England, which means no planning application is needed. But councils can remove that right by making an Article 4 direction, and many have done so in areas with high student or young professional demand.

Where an Article 4 direction applies, you need full planning permission to change use, and councils in saturated areas frequently refuse. Larger HMOs above six occupants generally need planning permission regardless. Check the planning position before you exchange, because a lender will not rescue a purchase that cannot lawfully be used as intended.

This is where HMO lending really differs, and it drives how much you can borrow.

A bricks-and-mortar valuation treats the property as a house and compares it to similar houses sold nearby. A six-bedroom terrace in a street of six-bedroom terraces might come back at 250,000 pounds, whatever it earns.

An investment or commercial valuation instead capitalises the income. If the property produces 26,000 pounds of net annual income and the valuer applies a 9 per cent yield, the value is 26,000 divided by 0.09, which is roughly 289,000 pounds.

Lenders take different positions. Many will lend on the lower of the two figures. Some will use investment value, but usually only for larger, purpose-adapted, licensed HMOs where there is a genuine market of investor buyers, and where the planning use is established. If you are relying on an uplift in investment value to refinance and pull your deposit back out, confirm the lender's approach in writing before you commit money to a conversion.

Most HMO lenders want landlord experience. A common expectation is at least six or twelve months of standard buy-to-let ownership before you take on an HMO, and lenders that will consider a first-time landlord on a small HMO will usually cap the room count and price the loan accordingly.

Other criteria to expect:

• A maximum number of lettable rooms, often somewhere between six and ten before the case moves to genuinely commercial lending
• Restrictions or higher pricing where tenants are students, or where any tenant receives housing benefit or Universal Credit
• Rules about whether individual room tenancies or a single joint tenancy are acceptable
• Requirements around fire safety certification, gas and electrical testing, and sometimes local authority sign-off
• Personal income minimums, often around 25,000 pounds, and a requirement that you already own your own home

The affordability test is still an interest cover ratio, commonly 125 per cent for basic-rate taxpayers and 145 per cent for higher-rate taxpayers at a stressed rate, but on an HMO it is rarely the binding constraint. The rent roll is usually far more than the stress test needs, which means valuation and criteria decide the case instead.

Take a six-bedroom HMO bought for 250,000 pounds with a 25 per cent deposit of 62,500 pounds, giving a loan of 187,500 pounds.

Rooms let at 550 pounds a month including bills. Six rooms fully occupied produce 3,300 pounds a month, or 39,600 pounds a year. Gross yield on the purchase price is 15.8 per cent, which is why the sector attracts attention.

Now take the costs off:

• Utilities, broadband and council tax, say 400 pounds a month, or 4,800 pounds a year
• Management at 12 per cent of rent, around 4,750 pounds
• Maintenance and communal cleaning, 3,000 pounds
• Licence fees amortised, insurance and safety certificates, 1,500 pounds
• Voids at an average of one empty room across the year, 6,600 pounds

That is 20,650 pounds of costs, leaving about 18,950 pounds before finance. Assume, purely for illustration, a pay rate of 5.5 per cent on the 187,500 pound interest-only loan, which is 10,312 pounds a year. The property nets roughly 8,600 pounds.

For comparison, run the ICR. Stressed at 5.5 per cent, the annual interest is 10,312 pounds, or 859 pounds a month. At 145 per cent cover the lender needs 1,246 pounds of monthly rent. The property produces 3,300 pounds, so the stress test passes comfortably. The pressure point is elsewhere.

An HMO is a small business, not a passive investment. You have six tenancies rather than one, six sets of referencing and deposits, and six opportunities a year for someone to leave. Bills are usually your problem, so a cold winter moves straight to your profit. Disputes between tenants become your problem too, and licensing conditions are enforced with real penalties for breaches.

Selling is also harder. The buyer pool for a licensed HMO in an Article 4 area is investors rather than families, which can be a strength in a strong market and a weakness in a weak one. Factor a longer sale period into your plans.

None of this argues against HMOs. It argues for going in with the licence position, the planning position and the lender's valuation approach all confirmed before you spend money.

Because HMO lending sits with a narrow group of specialist lenders whose criteria differ sharply, it is worth using the MortgageMatch directory to find an FCA-authorised broker who places HMO cases regularly. Most HMO lending is unregulated, but experienced advice is what keeps a valuation surprise from ending the purchase.