- House hacking is an investment strategy in which you live in one unit or room of a house you own and rent the others out.
- House hacking can help cover your monthly housing costs and help you generate income.
- House hacking can also help you qualify for low-down-payment loans reserved for primary residences.
Residential real estate has long been known as a wealth-builder. You buy a home, and as property values rise over time, so do the profits you eventually stand to gain. It’s a perk that’s particularly noticeable in today’s market, where home values are up over 19% in just the last year.
But selling a house isnt the only way to make money off of homeownership. With a method called house hacking, there may be a way to generate even more money from your property.
What is house hacking?
House hacking is an investment strategy where you buy a home using a low
down payment
residential mortgage and then rent out the home to generate income. Many consumers use it as a long-term investment strategy to both make money off of the property and also cover the costs of the mortgage.
“You’re basically purchasing a house with a very low down payment that you can eventually turn into an investment property,” says Devin Moreno, a longtime house-hacker and owner of Profusion Real Estate in Baltimore.
Here’s how it works: You purchase a multi-room or multi-unit residential property with the intent of living in one and renting out the others. This allows you to leverage conventional and FHA mortgage loans, which require as little as 3% to 3.5% as a down payment on primary residences. After closing on your loan, you move into the property, rent out the additional units, and use the rent to cover the costs of your mortgage and property costs.
“Interest rates are much lower for a primary residence than for an investment property,” says DJ Olhausen, a real estate agent with Realty ONE Group Pacific. “In order to qualify for these lower interest rates, the investor needs to live in the property for at least a year. It’s also advantageous because the house hacker will essentially be living in his or her new home for free, because the other tenants are paying rent and, therefore, the mortgage.”
While some consumers use this as a method to simply cover their housing expenses, for others, it’s a long-term investment strategy that can serve as a source of income for as long as you rent it out. It can also pave the way for other investments. After a year — the minimum amount most lenders require you to live in a home as your primary residence — you could move out, purchase another property, and use the same strategy, eventually building up a whole portfolio of income-generating real estate.
“It’s a great way to start a career in investing, especially when strapped for cash,” Olhausen says.
How to start house hacking in 7 steps
House hacking functions much like any traditional home purchase does, only with more emphasis put on researching the property and its rental potential.
Here are the steps to take if you’re considering house hacking for your next real estate purchase.
Step 1: Get your finances in order
To start, you’ll need to check your credit, as conventional loans require at least a 620
credit score
and FHA loans require a minimum of 580 (at least if you want the smallest down payment possible). If your credit scores aren’t there yet, you’ll need to work on improving it, which could take a bit of time — so make sure you check your credit scores well in advance.
Another thing you’ll need to do is make sure you have enough savings on hand. Moreno recommends enough to cover at least three months of your future property’s costs in case you can’t find renters right away, have a tenant who fails to pay, or come across other struggles. Your mortgage lender might also require that you have cash reserves before it’ll approve your loan.
Step 2: Get a Mortgage
The next step is to get preapproved for your mortgage. This requires filling out an application with a lender, agreeing to a credit check, and submitting various financial documents. Once you’re done, the lender will let you know if it’s willing to loan you money (ie, whether you’re prequalified), give you an estimate of your loan costs, and how much you qualify for. You can use this as a guideline for your property search since you’ll know how much house you can afford to buy.
Though both FHA and conventional loans can be options on a house hack, Moreno typically uses conventional financing on these ventures. For one, it comes with a smaller down payment (3% of the purchase price compared to 3.5%).
Though conventional loans do require Private Mortgage Insurance (PMI) with down payments this small, you can eventually cancel these premiums and reduce your monthly payment. With most FHA loans, on the other hand, you’ll be stuck paying MIP (Mortgage Insurance Premium) for the entirety of the loan term.
Step 3: Find a good agent
Partnering with a real estate agent should be next on your list — ideally, one who understands house hacking and has experience working with investors.
“Get a realtor who understands what house hacking is,” Moreno urges. “It’s not just simply looking at rooms but analyzing it for a long-term investment.”
An experienced agent can also help you find, screen, and place tenants once you have your property. This can reduce vacancies and help your property be more profitable.
Step 4: Research your market
You next need to determine where you’ll purchase your property. As Olhausen explains, “Do market research first to make sure fair market rental values will be sufficient to cover your mortgage.”
Researching local zoning laws is critical, too, as some communities do not allow rental properties. You should also study tenant protections and other laws that may impact your rental efforts.
“After you have done the math and know that your investment will be financially sound, make sure to understand your local and federal tenant laws,” Olhausen says.
Step 5: Find the right property
Finally, it’s time to find the property you want to house hack — the most important piece of the puzzle. For this part, Moreno recommends analyzing properties as “purely rentals.” This ensures you’ll make income off the property when you move out, and it also covers you in case of vacancies.
“You want to make sure the property gets you to zero rent — or at least remotely close to that — while you’re living there,” he says. “That means once you’re done living in it, you will have cash flow.”
When analyzing a property, consider its rent potential, the mortgage it would come with, and. the costs to maintain the home.
“Doing the math is a key element to success,” says Evelyn Fred, a broker associate with Baird & Warner. “Factor in all the costs, including insurance, property taxes, common area maintenance, and operating expenses.”
Step 6: Close on your loan
Once you’ve made an offer and the seller has accepted, your lender will order an appraisal, underwrite your loan, and schedule a closing date. This is when you’ll sign the paperwork, pay your down payment and closing costs, and get the keys to your property.
Step 7: Move in and find tenants
Last but not least, you’ll move into the property and work with your agent to find and screen tenants. When screening, Olhausen recommends conducting a background check, a credit check, and employment verification for each possible tenant.
“A successful tenant-landlord relationship is made upfront, so make sure you do your due diligence,” says Olhausen.
You might also consider enlisting a property management company to handle rent payments, maintenance of the property, and other to-dos if you’re not interested in taking a DIY approach. Just keep in mind that this will add an extra cost and could impact your investment’s profitability.
Pros and cons of house hacking
There are both advantages and drawbacks to the house hacking strategy. On the one hand, you might be able to cover your housing cost entirely. You might also enjoy a lucrative long-term investment or even build enough wealth to purchase additional properties and investment homes.
“Your tenant will be paying some or all of your mortgage for you while you build equity,” says Cliff Smith, a real estate broker and managing partner at The Agency New Canaan. “You can then use that equity to do a cash-out refinance and use the money to buy a second property.”
On the downside, there is some risk involved. Vacancies are inevitable, and though comprehensive tenant screening can help, there’s always the chance a renter fails to pay.
Additionally, house hacks can sometimes be tricky to get out of, Moreno says. If you wanted to sell the home, for example, you’d have to wait until every tenant left — and with leases staggered out, that could mean a few months with very little income coming in.
“With just one or two leases in effect, you’re not covering your mortgage,” says Moreno. “Then you have a bleeding asset.”
There’s also depreciation to think about. With more people living in the home, it will depreciate in value quicker, and you may need to invest more in maintenance and upkeep than you otherwise would have.
And finally, there’s the lack of privacy that comes with sharing your home — as well as the potential for conflict with your renters.
“You will have to share space with tenants, which can be frustrating if they do not match your personality type,” says Olhausen. “This may not be a great strategy for people who do not handle adversity well or lack in leadership qualities.”
Is house hacking right for you?
At the end of the day, the decision to house hack is a personal one. While house hacking can generate income and often cover your housing costs entirely, it does mean living with roommates or housemates for at least a year. There are also financial risks to consider, and your home may depreciate faster than if you had lived in it on your own.
If you do move forward, have a plan for how you’ll exit the investment if necessary, and make sure you have financial reserves on hand to weather any storm.
As Moreno puts it, “When you analyze the property purely as a rental, not just to eliminate your rent entirely but also for the exit strategy, that, in my opinion, is an effective house hack.”
