In this article, our expert team of independent mortgage advisers at PIL Southampton answers questions we’re often asked about HMO mortgages; how they work, how they differ from standard buy-to-let mortgages, and who they’re suitable for.
The definition of a HMO – a House in Multiple Occupation – is a property that is rented out to three or more tenants from different households, who share communal amenities like a kitchen, bathroom and lounge.
A HMO is usually student accommodation or a shared house of young professionals.
There is a consistent demand for HMOs in urban areas with a high concentration of students and young professionals and, if you are an experienced landlord, a HMO can be a good opportunity for you to get a better return on your investment.
HMO properties generally provide a higher rental yield than buy-to-let properties, often significantly higher, which can make them an attractive source of income for landlords.
There is also less risk of totally void periods, as you’re not reliant on one tenant.
As you would expect, the standard of the property, and the amenities it provides, like spacious bedrooms, en-suite bathrooms, good communal spaces, laundry facilities, smart home technology and so on, all have an impact on the property’s profitability.
Although the rental yield can be higher with a HMO, the higher operating costs that come with managing a HMO can substantially reduce the landlord’s net profitability.
They generally require more intensive and time-consuming day-to-day management. As well as complying with HMO-specific regulations (more on that later in this section), the landlord has to manage multiple rent payments and tenancy agreements and, with several tenants using shared facilities, there is more wear and tear which inevitably leads to more repairs, replacements and cleaning costs.
HMO properties have more strict licensing and safety regulations than buy-to-let properties, and these must be adhered to. If not, you could face a severe cost penalty.
Many local councils demand that landlords obtain specific HMO licenses and comply with specific rules regarding safety, room sizes, and provided amenities. If landlords fail to comply with these specifications, then legal action and/or fines can follow.
Lenders set a higher bar for HMOs when they’re looking at rental coverage ratios, which means that they need the mortgage applicant to prove that rental income is going to cover 125-140% of the mortgage payments, whereas buy-to-let mortgage applicants need to prove 120-125% rental income.
This difference accounts for HMOs tending to have more frequent void periods and higher management costs.
HMOs usually have a higher turnover of tenants, which gives landlords higher costs and more admin tasks regarding marketing availability, meeting tenants and getting references.
A buy-to-let property is rented to one tenant, whether that’s one individual, a couple or a group of people living together under one rental agreement.
As there’s only one tenant, the landlord can be more vulnerable to void periods, when there’s no income being generated by any tenants, and the landlord still needs to cover all continuing expenses like mortgage payments, insurance and local taxes.
Click here to read more about buy-to-let as a property investment.
A HMO has multiple tenancy agreements within the same property – the tenants could be strangers. They each have their own tenancy arrangement with the landlord and are not dependent on each other.
A buy-to-let property has a single tenant agreement with a landlord, whether it’s one individual, a couple or a family.
Interest rates for a HMO property tend to be 0.5%-1.5% higher than rates for a standard buy-to-let mortgage. This is due to the lender viewing the multi-tenant element of HMOs as higher risk.
Also, HMO mortgages generally have higher arrangement fees than buy-to-let mortgages and, because HMO properties need more detailed assessment, the valuation and survey costs are higher. Legal fees are also higher, due to the compliance reviews and additional licence checks that are required.
Buy-to-let mortgages typically require a lower deposit than a HMO mortgage, with a minimum deposit of 20-25% compared to a HMO mortgage generally needing a 25-35% deposit.
This equates to the LTV on a HMO mortgage being around the 65-75% mark, whereas the LTV on a buy-to-let mortgage can usually be 75-80%.
A HMO property comes with complex licensing and safety regulations, and needs more day-to-day management than a buy-to-let property.
Financing the purchase of a HMO property can be limited to specialist lenders and higher interest rates, and capital growth may be restricted in certain areas.
When you’re ready to sell, you may need to convert the property’s layout to increase your chances of selling it.
A HMO arrangement is most appropriate for an experienced landlord as it’s really helpful to have experience in handling tenants, regulations and property maintenance. In fact, many lenders stipulate that the mortgage applicant has at least 12 months’ experience of managing rental properties.
Investors looking for a business opportunity with decent earning potential often find HMOs an attractive proposition as they can generate substantially more income than a buy-to-let property.
If you are planning to manage the property yourself, then location is key – you want to be living close to the property for practicalities, which means that you are likely to be in a university town or an urban area where multiple occupancy is more in demand.
Buy-to-let properties are a good option for investors who are more risk averse and who are looking for a steady income and a simpler set up.
As they are more straightforward than HMOs, with fewer regulations and only one tenancy to manage, they can be popular with first-time landlords.
From a capital growth perspective, buy-to-let properties in robust residential areas often appreciate in value over the longer term.
If you are looking to invest in a property in a landlord capacity, whether you should choose a HMO or buy-to-let property will depend on several factors.
Our expert team of financial advisers is experienced in this field and can talk you through the pros and cons of each option, to help you to make the right decision for you.
They will also know what mortgage deals are available to you across the marketplace.
You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.