A Guide to House-Hacking

What is House-Hacking?

At its core, house hacking is renting out portions of your property to someone else while simultaneously living in it. Ideally this extra rental income covers the mortgage on the building and then some. At the very least, it is a very simple yet powerful tool to reduce net living costs by boosting income.

Brandon Turner of BiggerPockets, a large online real estate forum and networking group, often claims ownership to the term “house hacking.” It’s not a new concept, but he and the folks at BP have helped to popularize it. It certainly sounds better than “renting out the other side of your building for extra money.”

It must be noted that, despite its name, house “hacking” is completely legal (though there can be some restrictions against house hacking depending on the property). It may feel like cheating as you earn money on something that is normally a large expense, but, rest assured, it is fine.

How to House-Hack

To house-hack, naturally, you need to own a property. That property should at the least have extra rooms or living space. Ideally, it would have an entirely additional unit.

But how can I afford a property so that I can start house-hacking? Wouldn’t a building with that much extra space be too expensive? In some cases, yes. But, thankfully, house-hacking is unique in that it allows a person to take advantage of significantly cheaper financing because the property is still owner-occupied. Owner-occupied financing is significantly easier to afford than typical investment property financing.

In order to take advantage of owner-occupied financing, the property needs to be a residential building. A residential property can have one, two, three, or four units. When it has five units, it is considered “commercial” rather than residential, and that changes financing options significantly.

Anything less than five units, however, gets to use owner-occupied financing when the buyer lives in a unit. This means that you can buy a multi-unit property with this cheap financing.

The great thing about house-hacking is that, even if you move out of the property, you still get to keep that long-term and low-interest financing.

In the end, you come out with a rental property with relatively little money at the start. Or, if you stay in the property, you still live in it with most or even all of its bills paid for by rental income.

Advantages of House-hacking

House-hacking has many great advantages. While it’s not a fool proof strategy, with a little careful planning and research, you can really let this strategy work wonders for you!

Increased Income

This is the whole point of house-hacking. You are using your primary residence to bring in extra income.

This income can go a long way towards covering some or even all of your living expenses, effectively subsidizing your housing. you earn money directly from your renters

Cheap Financing

Because you are owner-occupying the property, you can take advantage of the low down payments and interest rates of owner-occupied mortgages rather than having to use an expensive commercial loan.

Residential mortgages include FHA loans and conventional mortgages from Fannie Mae or Freddie Mac. These types of loans have lower down payment requirements, as low as 3.5% in the case of an FHA loan, meaning you can get into an investment property with significantly less money than otherwise. These loans can be used to purchase properties classified as “residential,” meaning that you can buy a 1, 2, 3, or 4-unit property with them.

With a house-hack on a multi-unit building, lenders will allow you to add a portion of the estimated rental income from the other units (usually about 75 percent of market rent) onto your projected income. They will use that projected income in calculating your debt-to-income ratio, which typically is not allowed to be higher than 45 percent. In case you forgot what your DTI ratio is, check out this article. In short, this number divides your total monthly income by your monthly obligations.

In other words, with house-hacking, you can get a bigger mortgage than you otherwise would be allowed to get based on having a lower projected DTI ratio with the future rental income your property will bring in. This can be especially helpful for buying larger multi-unit buildings that you might otherwise be unable to qualify for with your current monthly income, which does not include the rent that the other units will bring in.

Even after you move-out of the building, you get to keep the cheap financing, making house-hacking a very versatile strategy.

Proximity to Property

Unlike owning a rental where you live far offsite, you can react extremely quickly to solve building issues yourself. This can take some stress out of property management since you can closely monitor problems.

You are literally living in the building, so if a tenant is having an issue, you are right there to take care of it.

Disadvantages of House-hacking

House-hacking does have its disadvantages. While the advantages are especially great, house-hacking is not necessarily as easy as it may sound. Some of the biggest disadvantages are explained below.

You Become a Landlord

This might not be a disadvantage in everyone’s eyes, but it is a big cost associated with house-hacking versus buying a traditional single-family residence. You

At the same time, house-hacking can be a great way to practice your property management skills on a small scale. You will also always be “on-site,” so you will be able to more easily react to problems that might arise.

Either way, be ready to devote some time into maintaining, advertising, renting, and managing your additional space!

Less Privacy

While it will shouldn’t come as a surprise, you have to share a property with other people which can be hard for some folks to adjust to. With house-hacking, you are sharing a building with others. These people are sometimes complete strangers depending on who you rent to. This can be uncomfortable for those who might be used to living in their own, exclusive space.

That said, living in a typical multi-unit building would feel like living in an apartment rather than a dorm or some other space with a shared living area. Each unit should still have plenty of privacy, just not as much as the average single-family home.

 

Decreased Flexibility

House-hacking decreases your flexibility in that you must either stay in or leave a unit empty for a certain amount of time when you use owner-occupied financing. This typically requirement usually lasts up to a year.

This means that you cannot take owner-occupied loans and then immediately rent your space out to someone else. Lender requirements will specify that at least one portion of the building must be kept exclusively for you in order to comply with regulations.

Vacancy Risk

Most importantly, you are still responsible for the mortgage payment and the bills even if you do not get every part of the building rented. No matter what, you are still solely responsible for paying the mortgage and all of the expenses on the property. Be prepared to be able to afford everything without the extra rent!

Coming into a house-hack with a solid emergency fund and additional savings can buy you plenty of time in the event that you do not have enough rent coming in in a particular month.

The risk of vacancy should never be overlooked!

Conclusion

House-hacking is one of many options that can be used to get started with real estate investing with relatively low risk. It’s a potentially very powerful tool that can limit your risk while still building significant wealth in real estate.

And its probably one of the best real estate strategies for beginners.

For investors wanting to get into the buy-and-hold game with as little money as possible, house hacking is an excellent option. It is also a great way to learn about property management on a small scale.

Even while you are living in the home, your tenants or roommates will help you to cover your mortgage as you build equity in the property and reduce your net living expenses drastically.

For more information on house hacking, be sure to check out househackhelp.com!