House hacking is a real estate investment strategy that homeowners can use to offset their mortgage payments. The strategy started in areas where it was too expensive for most people to own a house comfortably, but it's become quite widespread with the help of home-sharing platforms.
If you're the owner of a single-family or multi-unit home and looking for an easy way to ease into real estate investing, reduce your housing costs, or grow your wealth through passive income, then house hacking might be the right solution.
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What is house hacking?
House hacking is a real estate investing strategy involving buying a property and then renting out parts to offset your mortgage and other homeownership expenses. While it’s not a new practice, it has gained popularity in recent years.
For example, you may buy a duplex and live in one half while renting out the other half—or you might purchase a single-family home and rent out a spare room. Some homeowners even rent out their basement as storage space or allow people to park cars in their driveway for a fee.
The generated rental income can be used to pay down the home’s mortgage and build equity. When done correctly, it allows people to live in areas they may not otherwise be able to afford or even generates positive income.
Often, house hacking is used as a stepping stone into more serious real estate investing. By using the equity built up through the rental process, the homeowner can do a cash-out refinance and use the payout as a down payment on another property.
Key Takeaway When done appropriately, house hacking can help offset or even completely cover your monthly mortgage payments and other home-related expenses.
What are the benefits of hacking a house?
House hacking has numerous benefits and has become quite popular in the wake of the Financial Independence (FI) movement. The main benefit, of course, is that it allows people to cut down on their housing expenses significantly.
Importantly, it should be noted that house hacking makes it possible for many renters to transition into homeownership without any added expense. Because the purchase of a multifamily home can be classified as a primary residence, it is possible to get an affordable mortgage through both
Fannie Mae and
Freddie Mac. House hacking occurs when the purchaser lives in one unit and rents out the others.
Here are some of the other ways house hacking can benefit homeowners:
Reduces housing costs through income generated by renting out a portion of your property
Financing the property as a primary residence usually does not require a large down payment or high-interest rate
Lowers taxable income by acquiring tax write-offs
Positive income may eliminate bills such as homeowners insurance and property taxes
Allows people without a lot of capital to start investing in real estate
Easy way to learn how to be a landlord, as the tenant is right down the hall or next door
How to successfully house hack a property
There are a few basic steps you should follow to house hack a property, whether it’s a multifamily house or a single-family home:
Know your financing options
Financing a multifamily home isn’t any different from financing a single-family home, as long as it will be your primary residence.
Conventional mortgage loans are the most common way to finance a primary residence and typically require a down payment of at least 20% and a credit score of at least 620. In addition, you can count on closing costs totaling about 3% to 6% of the price of the home.
FHA and VA loans can be used to purchase properties with up to four units—with some caveats. To qualify for a VA loan, you must be an active duty or retired service member or the spouse of a service member. While anyone can be eligible for an FHA loan, MIP (mortgage insurance premium) is required, and you must have a debt-to-income ratio that’s less than 43%.
Rehabilitation loans (or 203K loans) let you purchase a home and work the costs of rehabilitating the house into the mortgage. You’ll need a credit score of at least 500 and a down payment of 3.5% to qualify for an FHA 203K loan, but other lenders may have more stringent requirements.
Find the right property to house hack
Finding a property to house hack doesn’t necessarily mean looking for your dream home. This is because, typically, homeowners will turn their primary residence into a rental property at some point down the road. Therefore, it makes sense to look for a property that will make a good rental (rather than one you’d like to live in year after year).
Factors to consider include:
Neighborhood: The area where you buy will (at least partially) determine the type of tenant and your vacancy rate. For example, if you buy near a university, you’ll likely rent to students, and your property may be vacant during the summer months.
Schools: If you’re hoping to rent out to families, consider the quality of the schools in the neighborhood, as well as access to parks, movies, shopping, etc.
Property taxes: Rates will likely vary across the area where you’re looking, and you’ll want to be aware of how much they’ll cost you every year.
Crime rate: It will be more challenging to find long-term tenants in a crime-ridden neighborhood, but your property is more likely to suffer damage from vandalism or theft.
Average rents: Rent will be your bread and butter, so it’s essential to know the area’s average. Make sure whatever rent you can pull in will be enough to cover the mortgage, property taxes,
homeowners insurance, and other expenses.
Vacancy rate: If the neighborhood has a high rate of vacancies, it’s unlikely you’ll be able to find a tenant anytime soon.
Crunch the numbers
Before making an offer on a house, take time to crunch the numbers and understand your potential income. After all, it doesn’t make sense to take on the responsibilities of a landlord if you’re going to end up in the hole.
For example, say you buy a single-family home for $350,000 with 20% down on a 3.5% 30-year fixed loan. Your mortgage payment would be $1,275 a month.
Now, let’s assume the house has a finished basement that you can rent out for $1,500 a month.
That amount of rent would fully cover your mortgage, plus leave you an extra $225 a month to put towards other expenses.
This investment would make sense, as it would help you move towards financial independence.
If, however, you take out an FHA loan and can only afford to put down 5%, your monthly mortgage payments would be $1,493 a month. So while rent would fully cover the mortgage, you wouldn’t have any leftover money to pay for other expenses.
Close escrow and ready the property
In addition to the down payment, closing costs on a conventional loan usually run between 3% and 5% of the loan amount. Closing costs include various fees buyers incur during real estate transactions, including title insurance/search fees, government recording fees, appraisals, surveys, attorney review, etc.
After closing on the property and moving in, the part that you plan on renting out will have to be made ready for a tenant. Depending on what you’re renting (single room, basement, detached garage, etc.), tasks may include:
Repairing or replacing appliances
Servicing the HVAC system
Repairing or replacing floors
Find the right tenant
Before interviewing potential tenants, it’s vital to understand the
Fair Housing Act and your state’s landlord/tenant laws to avoid breaking the rules.
Once you’re clear on regulations and the space is ready to be rented, these are the steps you should follow to screen tenants:
Determine minimum tenant criteria, including credit score, credit history, proof of employment, clean background check, and the ability to pay a security deposit/first month’s rent
Watch out for red flags like bankruptcy history, gaps in employment, evictions, criminal record, and late or missing payments
Pre-screen tenants by placing your criteria in the rental listing—most people who don’t qualify won’t bother to apply in the first place
Collect and review applications, check credit and criminal background, and verify other tenant information
Decide on a tenant and sign the lease
Key Takeaway Successfully hacking a house requires a lot of forethought and planning, including getting your financials in order, finding a suitable property, and learning about your area’s landlord/tenant laws.
How much money do you need to house hack?
Unless the property requires a lot of renovation, the amount of money needed to house hack is essentially the same as purchasing any other property. It all depends on the type of loan and the down payment size.
Conventional loans are loans not backed by the federal government. They usually require a down payment of 20%, though it may be possible to find options as low as 3%, depending on your financial situation and the lender.
FHA loans are backed by the Federal Housing Administration, and down payments can be as low as 3.5%. Most FHA loans require a mortgage insurance premium for a minimum of 11 years, and sometimes for the life of the loan.
VA loans are available to active duty service members, veterans, and surviving spouses. They do not require a down payment or mortgage insurance.
Can you house hack if you don’t own a home?
If you don’t currently own a home, there are still ways to hack your rental expenses. For instance, you can look for job opportunities that provide free or low-cost housing, such as a live-in caregiver or nanny. These jobs are often part-time, and you are free to go wherever you want when you’re not on duty.
Another option is to find short-term housing through house-sitting gigs. You may be asked to get mail, water plants, care for plants, or other light duties depending on the job. Be sure to register on a reputable house-sitting website, as it’s easy to get scammed.
Develop a house hacking strategy
To win at the house hacking game, try looking for a property with as many spaces as possible that you can use to generate revenue. The best deals involve hybrids of different strategies, including:
Single-family homes with an attached mother-in-law suite or extra rooms that you can rent out
Multifamily properties where the landlord lives in one unit and rents out the others
Homes with garages, basements, or attics that you can renovate into livable space
Property with a lot that can be used to build an additional dwelling unit (ADU), such as a tiny house
Pro tip In addition to rentable rooms, make sure the property has enough living space for the tenants to be comfortable. For instance, renting a room with a private bath and sitting space is preferable to just a bedroom with shared common areas.
Home insurance and house hacking
In a nutshell: house hacking should not affect your
homeowners insurance. However, you should ensure that your tenants have
renters insurance, as your policy only covers your personal belongings, not theirs.
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