Do lenders charge higher interest rates for large HMOs?

Navigating the mortgage landscape for Houses in Multiple Occupation (HMOs) requires specialist knowledge, particularly when dealing with large properties that house seven or more tenants. Due to the inherent complexity, higher regulatory burden, and increased risk associated with large-scale management, specialist lenders typically charge higher interest rates for these substantial investments compared to standard buy-to-let (BTL) mortgages or even smaller, standard HMO properties.

Do lenders charge higher interest rates for large HMOs, and how is the cost determined?

The interest rate applied to any property loan is primarily a function of risk. When a property transitions from a standard family home or a small, regulated HMO (typically 3-6 tenants) to a large HMO (often 7+ tenants), the perceived risk to the lender escalates significantly. This increase in risk translates directly into higher interest rates and stricter lending criteria.

Understanding the Large HMO Definition and Risk Profile

In the UK, the definition of an HMO is based on the number of unrelated tenants sharing common facilities. While standard HMOs (under five tenants) often sit within the scope of many mainstream buy-to-let lenders, large HMOs typically fall into a specialist or commercial lending category.

Regulatory and Licensing Complexity

A key factor driving interest rates up is licensing. Any property housing five or more people forming two or more separate households must have a mandatory HMO license granted by the local authority. However, lenders often view HMOs with seven or more rooms as significantly more complex, sometimes classifying them as Sui Generis (a class of their own) for planning purposes.

The regulations governing large HMOs are rigorous. Lenders must be satisfied that the borrower understands and adheres to the extensive requirements for fire safety, room sizes, and amenities. Failure to maintain mandatory licensing or compliance can result in severe penalties and even repossession of the property by the local authority, making the security less attractive to the lender. You can review the current mandatory licensing requirements and rules via the UK government website on HMO licensing.

Valuation and Exit Strategy

Valuing a large HMO is inherently more challenging than valuing a standard BTL property. Valuers often use the ‘investment’ or ‘commercial’ method, basing the property’s value on its potential rental income (yield) rather than comparable local sales. This commercial valuation approach introduces variability and requires specialist surveyor expertise, which adds another layer of complexity that lenders must price into the risk.

Furthermore, if the lender needs to repossess and sell the property, the market for a large, specialised HMO is smaller than for a standard house. This reduced liquidity means the lender faces a potentially longer sales period and a smaller pool of buyers, justifying a higher interest rate to cover the increased risk of loss.

Why Higher Rates Apply to Large HMO Lending

Large HMO lending is generally segregated from standard BTL products for several commercial reasons:

• Increased Operational Management: Managing 7+ tenants requires significant expertise, administration, and resource allocation (cleaning, maintenance, tenant turnover). Lenders assess the borrower’s experience closely.
• Fewer Specialist Lenders: The large HMO market is served by a smaller pool of specialist finance providers. Less competition naturally allows these lenders to set higher margins, reflected in the interest rate.
• Capital Requirements: Due to the commercial nature and regulatory environment, lenders must set aside more capital for large HMO loans, which increases the overall cost of funding the loan.
• Higher Loan-to-Value (LTV) Risk: While lenders usually offer a lower LTV for large HMOs (requiring a larger deposit from the investor), any necessary sale carries a higher potential for complexity and discounted prices if the sale is forced.

Factors Influencing Your Specific HMO Interest Rate

While large HMOs attract a higher baseline interest rate, your specific rate will depend on a combination of factors related to the property and the borrower:

1. Loan-to-Value (LTV) Ratio

This is arguably the most critical factor. The smaller the loan is relative to the property’s value (meaning the larger your deposit), the lower the risk is to the lender, and consequently, the lower the interest rate will typically be.

2. Borrower Experience and Portfolio Strength

Lenders heavily favour experienced landlords with a proven track record of managing similar-sized HMOs successfully. A robust existing property portfolio may qualify you for better rates than a first-time large HMO investor.

3. Location and Demand

Properties in areas with high tenant demand (e.g., near universities or large hospitals) may be viewed more favourably than those in marginal locations, potentially securing a slightly better rate.

4. Your Personal Financial Profile

Your personal credit history and overall financial health play a crucial role. Any history of defaults, County Court Judgments (CCJs), or severe arrears will likely result in higher interest rates, regardless of the property quality.

Understanding your current credit standing is vital before applying for specialist finance. Get your free credit search here. It’s free for 30 days and costs £14.99 per month thereafter if you don’t cancel it. You can cancel at anytime. (Ad)

Financing HMO Conversion and Refurbishment

Many large HMO investments start with the purchase of a residential property that requires significant conversion and refurbishment to meet HMO standards. In these scenarios, investors often rely on bridging finance, which carries its own considerations regarding cost and risk.

Bridging Loans for Large HMOs

Bridging loans are short-term, flexible loans designed to ‘bridge the gap’ until long-term finance (the commercial HMO mortgage) is secured or the property is sold. They are faster to arrange but generally carry much higher interest rates than standard mortgages.

• Interest Structure: Most bridging loans roll up the interest into the loan amount, meaning you typically do not make monthly interest payments. The entire principal and accrued interest are paid back when the bridge is redeemed.
• Lender Assessment: Lenders assess the viability of the exit strategy—how you plan to pay off the bridging loan (e.g., refinancing onto an HMO mortgage or selling the completed property). A weak exit strategy will increase the loan cost or prevent lending entirely.

Risk Warning: While bridging finance can be an invaluable tool for converting properties, it is specialist debt. Your property may be at risk if repayments are not made. Consequences of default can include legal action, repossession, increased interest rates, and the imposition of additional charges, severely impacting your investment strategy.

People also asked

How much deposit is required for a large HMO mortgage?

Specialist lenders typically require a larger deposit for large HMOs compared to standard BTLs, often seeking a Loan-to-Value (LTV) of 75% or less, meaning you usually need a minimum deposit of 25% to 30% of the property value, and sometimes more, depending on the complexity of the asset.

Is it harder to get a mortgage for an HMO with 7 bedrooms?

Yes, securing a mortgage for a 7-bedroom HMO is generally harder because it falls into the specialist commercial lending space, which involves fewer lenders, more stringent underwriting criteria, and requires the borrower to demonstrate extensive property management experience and compliance knowledge.

Are HMO mortgages considered commercial finance?

While many small HMOs (3-6 tenants) are treated as regulated BTL products, large HMOs (often 7+ tenants) are typically classified by lenders as commercial finance due to the complexity of the operation, the scale of the rental income, and the specialist nature of the regulatory requirements.

Do HMOs provide a better return than standard buy-to-let properties?

HMOs generally offer the potential for higher gross rental yields compared to standard single-tenancy buy-to-let properties because rent is collected per room. However, this potential higher return must be balanced against significantly higher management costs, greater regulatory burdens, and higher associated interest rates.

What is the meaning of ‘Sui Generis’ in relation to property?

Sui Generis is a planning term meaning ‘of its own kind’. In UK property law, large HMOs (usually those that house more than six unrelated tenants) often require a specific change of use planning permission classified as Sui Generis, separating them from the standard C4 (HMO) planning class.

Conclusion: Seeking Expert Advice

While the answer to “Do lenders charge higher interest rates for large HMOs?” is unequivocally yes, investors should not be deterred. These increased costs reflect the higher rental yield potential and professional management required. The key to successful financing is working with a specialist mortgage broker who understands the intricacies of the commercial and specialist HMO lending market.

A broker can compare the small pool of available products, factoring in criteria like your experience and the property’s specific licensing requirements, ensuring you secure the most competitive rate available for this highly specialised class of property investment.