Carefully evaluate the DSCR requirement of lenders, accurately calculate the DSCR of the property, and meet or exceed the lender’s DSCR threshold while considering other key investment metrics.
What is DSCR and Why is it Important for HMO Property Investing?
DSCR or Debt Service Coverage Ratio is an important financial metric that indicates an investment property’s ability to cover its debt obligations. It measures the ratio of a property’s net operating income to its annual debt payments.
For HMO (House in Multiple Occupation) property investing in the UK, evaluating DSCR is crucial because lenders and banks require a minimum DSCR to approve financing. A higher DSCR implies lower risk for the lender.
So how exactly should property investors use DSCR when investing in HMO properties in the UK market? What steps should you take? Let’s find out.
What DSCR Rate Do Lenders Require for HMO Property Finance?
The typical DSCR range required by most lenders for HMO property finance is 1.25 to 1.30. This means the property’s net operating income should be at least 125% to 130% of the annual debt service.
However, the exact DSCR requirement can vary by lender based on their own credit policies and risk appetite. Some lenders may accept a lower DSCR of 1.20 or even 1.15 for strong borrowers with a solid history. On the other hand, certain lenders might require a higher DSCR of 1.40 or more for new investors or those with limited credit profile.
As a property investor looking to leverage DSCR for HMO funding, your first step should be to research and find out the specific DSCR threshold of lenders you plan to approach. This will help set expectations when assessing potential deals.
How Do You Calculate DSCR for an HMO Property Investment?
Once you know the lender’s DSCR requirement, the next step is to calculate the DSCR for the HMO property you wish to acquire and fund.
The DSCR calculation is fairly straightforward:
DSCR = Net Operating Income / Annual Debt Service
Let’s break this down further:
- Net Operating Income (NOI) – This is the annual rental income generated by the property minus all operating expenses like maintenance, taxes, insurance, property management fees etc. Essentially, it’s the profit left after paying all regular costs of running the HMO asset.
- Annual Debt Service – It is the total annual loan repayment consisting of principal and interest. For an interest-only mortgage, it would only be the interest portion.
As an example, if a 6-bed HMO property generates £60,000 in annual rental income and has £15,000 in annual operating expenses, the NOI is £45,000. If the mortgage is £200,000 amortized over 25 years at 5% interest, the annual debt service is £13,000.
Therefore, the DSCR is £45,000 / £13,000 = 3.46
This exceeds the typical lender’s DSCR threshold and implies the HMO investment has sufficient income to cover debt payments.
Does My HMO Property DSCR Meet Lender Requirements?
Once you have calculated the HMO asset DSCR, the next crucial step is to evaluate if it meets or exceeds the lender’s stipulated ratio.
If your property DSCR is lower than what the lender expects, they may decline financing even if other factors like LTV are favorable.
For instance, if the lender requires a 1.25 DSCR but your property only achieves a 1.15 ratio, it falls short of their criteria. You will need to either boost the income, reduce expenses, opt for lower leverage, or find an alternate lender with a lower DSCR requirement.
Meeting the DSCR threshold gives you the best shot at securing funding for your HMO investment at competitive rates. It indicates you can comfortably service the debt.
What Other Metrics Matter for HMO Property Investing?
While DSCR is critical, also pay attention to other key parameters when analyzing an HMO property deal:
Loan-to-Value (LTV) Ratio
Most lenders cap LTV at 70-75% for HMO properties. The lower the LTV, the easier it is to obtain financing.
Aim for a yield of at least 8-10% based on current rents and property price. Higher yields mean better returns.
Look for properties with full occupancy or minor vacancies. Hard-to-fill HMOs signal higher risk.
Regulations and Licensing
Ensure the property meets all legal HMO requirements of the local council.
Evaluating these factors along with DSCR will lead to informed HMO investing decisions.
Portfolio Landlords – Extra DSCR Requirements to Note
If you are a portfolio landlord owning multiple rental properties, be aware that lenders will look at your entire profile when assessing DSCR, not just the individual asset.
Specifically for portfolio landlords in the UK:
- You must provide a portfolio summary showing ALL mortgage payments across your properties. Lenders will evaluate DSCR at a consolidated level.
- Submit Assured Shorthold Tenancy Agreements as proof of rental income for your 3 highest earning properties. This supports income estimates.
- If investing in a multi-unit block HMO or large HMO, the property DSCR requirements are stricter, and the deal may be declined if ratios are not met satisfactorily.
Keep these additional parameters in mind as a portfolio HMO property investor using DSCR.
In Summary – A Prudent Approach to Using DSCR for UK HMO Investing
Here are some key tips on successfully utilizing DSCR when investing in HMO properties in the UK:
- Research lender DSCR requirements in-depth and set clear expectations.
- Accurately calculate the DSCR for each potential HMO property deal.
- Confirm the HMO asset DSCR meets or exceeds the lender’s policy threshold.
- Analyze other factors like LTV, yields, occupancy, and regulations.
- Portfolio landlords should provide extra DSCR-related documents.
- Exercise caution when investing in larger HMOs with lower DSCR.
Following this prudent approach will help you leverage DSCR effectively for HMO property financing and build a high-performing investment portfolio.