What is House Hacking?
Have you ever wanted to buy a house without paying for it? If so, house hacking may be for you. No, house hacking isn’t using computer hackers to steal a house. It’s a way to have tenants at your home while you’re paying off the mortgage.
The rent from the tenants may pay the entire monthly mortgage payment and leave some income for you. In that case, you’ve bought a house paid for by your tenants. Even if your rental income doesn’t pay as much as your mortgage payment, you will have substantially reduced your mortgage cost.
The home you buy may be a multi-family property, such as a duplex. You live on one side and the tenant lives on the other. Or you may be only renting out a room. We’ll discuss the many options for house hacking in the sections below.
Here, we’ll talk about the benefits of house hacking, some popular house hacking strategies, how to finance your house hacking plan, and some tips about being an effective landlord.
The Ways House Hacking Can Help You
You want to buy your first house. But you know there’s a recession coming and are concerned about the risk of not being able to make your mortgage payments. Having the right tenant or tenants in the house reduces the risk of default.
With a tenant on the property, you can build equity quicker since you can make larger mortgage payments if you choose. Since you live in the house, you can finance it as a primary residence instead of a rental property. That means you have better financing options than if you’re borrowing to purchase a rental property.
Unlike with repairs for a primary residence, expenses related to repairs and maintenance of the rental portion of the property are tax deductible.
If you are concerned about your employer transferring you to another city, house hacking gives you the flexibility you need. Instead of struggling to sell the house, you can add tenants for the space you’re vacating. You may have enough rental income to pay for the mortgage on your first house in the new city.
Since you’re an on-site landlord, you don’t have to travel back and forth to the property to complete any necessary landlord duties. That makes it easier with your first experience as a landlord. From your experience, you may decide to become a lifelong real estate investor.
This passive income you’re earning from your tenants can go toward buying other rental properties. If you would prefer to diversify your investments, you may channel this additional income into the stock market or other investment instruments. As you can see, the key to building wealth is to let your money work for you. House hacking is a great way to do that.
Now that you’ve seen what house hacking can do for you, you’re probably wondering how to get started. The first keys are to adopt the right strategy and pick the right house. We’ll discuss these issues in more detail in the next section.
Related Reading: What is rental arbitrage?
The Right House Hacking Strategy for You
There’s more than one way to hack a house. Which way is best for you will depend on your goals and circumstances. Some of the more common house hacks include:
- Use a multifamily home
- Rent rooms out
- Build a second dwelling on the property
As you’ll see in the financing section, you can finance a home divided into as many as four units as if it’s your primary residence. That means you’ll be eligible for advantageous terms offered for Federal Housing Administration (FHA) backed and Veterans Administration (VA) backed loans.
If you qualify for the right mortgage, you can have up to three tenant families living on the same property where you live. This is one of the easiest ways to cover your mortgage with rental income.
With a house that’s already divided into apartments, you should have no issue with local ordinances or homeowners associations (HOA) rules. But it’s still a good idea to check. The last thing you want is to learn you can’t have tenants after you have bought the house.
There are a few different ways to handle room rentals. The easiest way may be to find a house that has an attic, basement, or room over the garage. You can fix these areas up into separate apartments. Add a kitchenette, toilet, essential HVAC, and electricity, and you have an apartment you can rent out.
You could look for long-term tenants or try the short rental services like Vrbo and Airbnb. Before buying a house with this in mind, you need to know that you have no local ordinances or HOA regulations that prevent this. It’s also a good idea to take a careful look at the house to make sure your plans to turn the basement, attic, or garage into apartments are feasible.
Build a Second Dwelling on the Property
These second dwellings are sometimes called additional dwelling units (ADU). Technically, changing extra house space into apartments falls under the ADU label. We covered that in the basement/attic/garage section.
Here, we’re referring to putting tiny homes on to the property. It’s surprising how many people will pay high rents to live in a 200 square foot tiny house. It’s a good idea to lean toward the high end of what’s considered a tiny house, which is up to 600 square feet.
In 1950, the average home size was 983 square feet. There’s nothing in the historical record showing that people were miserable with their home size in 1950. At 600 square feet, that’s plenty for a one bedroom home.
Make sure there are no city ordinances or HOA rules preventing you from building a second structure on the property before purchasing a home with this intent. Since you may accomplish a similar result by renting out space in your backyard for a mobile home or RV, you need to make sure there are no rules preventing this.
Financing Your House Hack
As of November 10, 2022, the average 30-year fixed mortgage rate in America is 7.08%. The Federal Reserve Economic Database (FRED) provides this rate. You’ll find different rates on other websites. This is the average nationwide rate. Your rate will depend on your credit score, credit history, your location, and other factors.
The rate for a 30-year fixed mortgage that’s FHA or VA backed should be about ½ percent lower. The rate for an investment property is about ½ percent more than for a primary residence. With a VA-backed mortgage, a down payment is not required.
That’s at least a 1% less than the mortgage rate if you were buying a rental property but not living in one of the units. The table below shows this makes a big difference.
As you can see, your monthly payments are a little over 10% more for the investment property than for the house hacked property. The only difference is that you live in the house hack version.
Related Reading: Should I sell or rent the house I inherited?
Being a Landlord
With all these advantages to house hacking, why isn't everyone doing it? It's because not only is there some work involved, but there are also some risks in being a landlord.
House hacking isn’t new. It’s probably a good idea for anyone considering house hacking to watch the 1990 classic movie, Pacific Heights, about a couple that tried house hacking. Of course, Hollywood had to make an extreme case to sell tickets. But the moral of the story is the same — do your due diligence before accepting a tenant. You need to:
- Discuss the security deposit, rent, and required background checks with any prospects
- Get written permission for the background checks and credit reports
- Verify income
- Charge an application fee
You need to charge the fee as you’ll not only have to put time into the process, but you’ll also incur expenses.
Since you only have one to three units to rent, you should have multiple prospective tenants to choose from. Choose the one that’s most likely to fit in and most likely to pay the rent.
Before tenants move in, you must determine if you need landlord insurance. The answer to that question may depend on the type of house hack used. Where the rental property is separate, you always need landlord insurance. Landlord insurance covers property damage from fire and storms similar to a homeowners policy, but it can also cover lost rental income.
Landlord insurance covers accidental damage by the tenant. You can add vandalism coverage. Landlord insurance might have prevented the house hackers’ complete loss in the aforementioned movie.
You need to know if there are any gaps in your homeowners’ coverage when your house hack. Are additional dwelling units covered? You need to know.
As a new landlord, there’s a lot to learn, such as if you need landlord insurance with your house hack. Steadily is the best rated landlord insurance company in America. Contact us today to make sure you have adequate coverage. Or get a quick quote online. We will make sure you don’t have any unwelcome surprises when it’s time to file an insurance claim.
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