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The Beginner's Guide to House Hacking

Written by Ben Mizes Posted On Sunday, 10 November 2019 05:30

The internet loves the word “hack” because it usually means there’s a creative, inexpensive shortcut that solves a common problem. But it also often results in a solution that’s not quite up to par, which is why many investors may have turned a deaf ear to the concept of house hacking. 

In reality, house hacking helps you break into the real estate investment market while also covering your own housing expenses. 

That last part is huge. For most people, their biggest bill is their rent or mortgage, with the average rent in the United States hitting an all-time high of $1,405 last year. They’re spending hundreds of dollars each month to keep a roof over their head, money that could otherwise be used to build wealth or achieve financial freedom. Home prices have skyrocketed in the last 30 years while household incomes have remained largely the same, so home buyers need to find creative ways to afford their monthly payments.

Whether you’re a real estate investor newbie or are a seasoned investor looking for a new way to build wealth, house hacking not only provides an attractive income, but can also allow you to live for free.

What is House Hacking?

By definition, house hacking is the act of turning your investment property into your primary residence. In some cases, you might convert a single-family home into a duplex or rent out a bedroom. But typically, the practice applies to multi-family residences, one of which is yours and others are rented out to other tenants.

As the landlord, you receive rent from the other units, which will ideally be more than enough to cover the mortgage and your own living expenses. When this is done correctly, you can use the leftover money to quickly increase your investment capital. This is different than the house flipping popularized by HGTV – it’s not about a quick flip.  

However, there is some risk involved. If you end up with a money pit, you could end up spending more than you’re collecting in rent, which would essentially defeat the purpose of house hacking. 

House Hacking Benefits

Let’s say your household brings in an average salary of $73,298 each year. In a recent report, Americans spent an average of $19,884 on housing, which is roughly 27% of your annual pre-tax salary. Imagine what you could do with an extra $19,884 ever year! 

Maybe you’d want to put it toward more rental properties to grow your portfolio. Or, perhaps you’d want to save it to pay for your kid’s college, their first car, or even retire early!

Here’s a quick example of what house hacking looks like in action, based on a property purchased last year using this exact strategy:

• Four-plex property: $220,000 including closing costs and repair credits
• Cash to close: $10,000 including the down payment, property inspection, and $3,000 in additional repairs
• Monthly rent from 3 units: $2,000
• Monthly mortgage payment: $1,400
• Monthly cash flow: $600
• Budgeted expenses: $600
• Final Income: $0
• Money saved from not paying rent: $8,400 per year

There wasn’t money earned on this deal, but rent was free. Instead, there was enough money to cover expenses and repairs. As for the money saved on housing, it was now invested in building wealth — $8,400 per year.

But aside from living essentially for free, house hacking provides so much more. For some investors who are doing this, it’s their ticket to early retirement. For others, it’s a long-term plan for making money and allowing you the financial independence you crave. 

What You Need

Successful house hacking relies on three core components:

• A multi-unit investment property
• Affordable down payment
• Low fixed-rate mortgage

Ideally, you can find a below market value property that will help you build instant equity. We recommend only considering properties where the total rental income is at least 1% of the property’s purchase price. 

Here’s another bit of good news: if you plan on using the property as a primary residence, you can usually find more favorable financing. 

Money is usually one of the biggest obstacles that prevents people from investing in real estate. But when you can get a mortgage with a low down payment and low interest rate, like a 3.5% FHA loan, the barrier to entry is much lower. 

The right real estate agent can make all the difference, especially when you can work with an investor-friendly one. Lean on your agent throughout the process, from finding investment properties to exploring financing options. You’ll likely get a lot farther with an agent than you could going it alone or using an iBuyer like Offerpad, especially if you’re new to house hacking. 

Where to Start

We’ve found that the best way to implement this investment strategy is in the Midwest where property is affordable, but it can also work in other parts of the country (e.g. renting out an Airbnb in Denver to cover your mortgage). 

You’ll want to do some digging in your local market to find properties below market value or at least affordable. Much of the country right now is still experiencing a seller’s market, but there have been several signs that’s about to change. The market looks to be cooling, which is great news for investors who want to score a potentially good deal on a multifamily property.

Foreclosed homes, HUD properties, or fixer-uppers are good labels to start with. When looking at these homes, remember you’ll likely need to do a little work to get them move-in ready. Look at the roof, the plumbing, HVAC system, foundation, condition of the windows and doors, appliances, and the kitchen and bathroom.

You’re not likely to find a property that’s in good condition, in a good neighborhood, AND priced affordably. You’ll usually have to bend on something, and we recommend prioritizing the things you can’t change.

Getting Financing

Getting a mortgage for a house hack is similar to getting a mortgage for any primary residence, but it’s a little harder. You may have certain requirements to meet that you otherwise wouldn’t.

You’ll need to know your low down payment mortgage options, which in this case would be a VA Loan, FHA Loan, FHA 203K, or Fannie Mae Homestyle Renovation Loan, to name a few. 

Look at the credit score requirements, down payment options, property eligibility requirements, if you need mortgage insurance, and whether you can wrap home improvement costs into the loan. 

It’s a good idea to get pre-approved for a mortgage first to be ready when you find the right property.

After Closing

You close on the property, fix it up, start getting tenants, and BOOM — now you’re a landlord.  One upside to living on property is being able to manage it yourself rather than outsourcing to a property manager. 

First and foremost, remember this is a business, and you’ll need to learn quickly what to do and what not to do if you want your house hack to be profitable.

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