House hacking is the art of making a primary residence out of an investment property, having rental income cover the homeowner’s costs. Millennial Money calls it a way to “use other people’s money (tenant rent) to pay down the mortgage and live for free.”
Of course, this is not a new idea in real estate investing, but millennial buyers may have rebranded it as a solution to a problem afflicting their generation. Younger home shoppers can quickly hit road blocks buying a home. Reasonably priced homes are in low supply and high demand. This imbalance has continually pressed home prices up, making it hard for first-time buyers to enter the market.
Hopeful buyers may read websites that tout house hacking as the best pathway to financial success. The housing market is on a roll; why not tap into the market for income?
Some hold investment properties only as long as they need to. Other home hackers repeatedly buy, building equity as they go and saving rental income for future down payments. As experienced investors can qualify for larger loans, their buying becomes more lucrative over time.
Choosing the Right House to Hack? It’s a Balancing Act.
Some people buy a duplex property. It’s a great way to retain privacy, and to pick the people who’ll be living live next door. Others buy homes with accessory dwelling units or small cottages on the properties. Other set-ups could work, including basement or upper floor apartments. Helpful elements are separate entries, kitchens, bathrooms, and laundry nooks.
It’s a balancing act to pick a location that will attract reliable renters, yet one that’s not too expensive and too highly taxed. It takes some careful research to know the relationship the price of the house and its potential return on the investment.
The house hacker must keep the house long enough for the investment to make financial sense. Those who draw enough rental income can make extra mortgage payments to lower the debt principal. In this way, they build equity faster, and profit earlier if they sell the property.
Again, location is key. The buyer must take into account all the costs: closing fees, mortgage principal and interest, home and title insurance, property tax, repairs and general maintenance. There can be dry periods between tenants or when the existing tenants become unable to pay the rent for a month or more. If homes in the area have a very good track record of appreciation, those costs will be offset. Given the inevitable fluctuations in real estate values and the unpredictability of the job market, buying a home in a popular and resilient neighborhood is essential.
Getting Approved for a Mortgage: What Works?
Mortgage professionals point out that getting a mortgage for a multi-unit house is not the same as getting a regular mortgage. The underwriting guidelines differ. And the borrower needs a higher credit score. Fannie Mae requires 680 — in contrast to a minimum score of 620 for buying a single home.
Yet the mortgage specialists add that your array of options is broader if you’ll be living in your investment property as opposed to being a distant landlord. So, house hackers may be eligible for low-down payment FHA loans, VA loans, and conventional loan plans such as Freddie Mac’s Home Possible®. Insurance premiums, too, can be lower when an investor-owner lives onsite. The rationale? Owners whose investment properties are also their primary residences tend to do proactive maintenance — averting hazards, incidents, and claims.
Where the buyer will not be putting 20 percent down on the purchase, private mortgage insurance may be a necessary element of the investment. Accepting a private mortgage insurance requirement is one way to get financing that would otherwise elude the beginner. If the buyer can pay the loan down monthly and obtain a healthy appreciation in the home’s value, regular rental income could help the owner refinance the loan later, under better terms.
☛ Fine print: Mortgage payment amounts and PMI premiums appear on the borrower’s loan estimate during the approval process, and in the closing disclosure during preparation for closing.
A Rundown of Common Benefits and Pitfalls of House Hacking
Weighing the pros and cons? Here’s an outline to start.
Assume the buyer has checked local ordinances and zoning rules, to ensure rental homes are allowed, and that the section of the house to be rented out is a compliant residential unit. Under the right circumstances, multiple rewards await the investor-owner who lives in the home:
- Income. Collecting rent can cover a good portion of a home’s mortgage, property taxes, and home insurance costs.
- Tax deductions. Income needs to be reported, but an owner can deduct many expenses for a rental property.
- Equity building. Over time, loan debt gets lower. And, optimally, the property’s market value goes up.
- Awareness. Living in an investment property allows the owner to keep tabs on it. This makes it very hard, for example, for a renter to sublet the space contrary to local ordinances or language in the lease.
At the same time, house hacking carries downsides and risks:
- Less privacy. Having housemates can make it hard to maintain personal space. Use the lease to set clear boundaries. To further fortify those boundaries, you might wish to have a property management handle renter relations. Either way, sharing space in an investment property comes at a cost.
- Compromised choices. Unless the rental space has access to a separate patio or balcony, kitchen and laundry space, and HVAC system, you’ll need to accommodate other people’s work hours, habits and preferences.
- Opportunity costs. The owner of a rental property gives up many hours that could be available for other projects. Much time is spent on finding and vetting renters, chasing late rent payments and bills, and fielding extra calls.
- Wear and tear. A rental property is high-maintenance. Heavy use can damage appliances and systems.
- Noise, parking issues, and activity. And there’s always a possibility that surrounding homeowners are not as pleased with your house hacking idea as you are.
Note that it’s harder to live with difficult housemates than to deal with problematic renters from a distance. Boundary-setting can be stressful for the renters and owner alike.
Six Pro Tips for House Hacking Success
What are the keys to avoiding stress and achieving house-hacking heaven? Well, there are a few steps you can take to reduce risks and avert annoyances. We’ll list a half-dozen here:
- Establish an ample budget for repairs. Anticipate heavy use of every system, feature, and appliance in and around the house. In some cases, you’ll have to tap the bulk of your rental income for taxes and upkeep costs. Does the house you’re buying need a new roof or HVAC? Are the appliances past their warranty dates? How much will you need for indoor and garden maintenance, balcony replacements, snow removal, sewer and utility fees? Add a cushion for the possibility that someone will lose their job and you may need to consider rent forgiveness at some point.
- Consider buying in a place that’s lively and active year-round. A continual supply of visiting student workers and professionals is a major boon. Have an online presence so your openings are visible to them.
- Have a local real estate lawyer draft your first lease agreement, setting forth your expectations for residents.
- Know the rules on security deposits, and, to cover potential damage, require one from each renter. Carefully inform your renters what damage goes beyond wear and tear and creates a reason for withholding funds from the deposit.
- Establish a firm ceiling on how long a renter’s guests can stay in the house.
- Meet prospective housemates in advance. Walk through the space, read the lease and take notes together, memorializing priorities and concerns, and how you discussed them.
Perhaps the best tip of all is to find a house you really like, in a location that suits you. One that you could imagine calling your home for good. Not that you need to commit to forever now. Having an investment home as your primary residence can create flexibility and options in the future.
All Things Considered…
House hacking differs from holding an investment property remotely. The hopeful home hacker needs to ask different questions of real estate professionals and mortgage specialists. And for many people, sharing space with housemates does not exactly seem like “using other people’s money to live for free.” Yet house hacking does enable some people to become first-time home buyers — and, ultimately, experienced real estate investors.
Photo credit: Ralph (Ravi) Kayden, via Unsplash.