Introduction
House hacking is the art of renting out your home’s extra units to generate income in order to help pay for your mortgage. This can be a great way to get into real estate investing without breaking the bank.
For example, if you’re looking for an investment property but don’t have enough cash on hand—or want someplace other than your primary residence where you can rent out rooms—then house hacking might be exactly what you need!
What is house hacking
House hacking is an investment strategy that involves buying a home and renting out rooms of the home while you live in it for free or at a discounted price.
If you’re looking for a way to earn passive income through rentals, this is it!
As long as you understand the ins and outs of house hacking, you can make a lot of money by renting out your properties.
The concept of house hacking is simple
You buy a small multi-family home to live in one unit and rent out the other units to offset your expenses. This is typically done using multifamily properties of up to four units because FHA loans allow multifamily homes of up to four units.
House hacking is a great way to get into real estate investing with a low down payment. You can buy duplexes, triplexes, or single-family homes that you rent out as multiple units.
Then you live in one and rent out the others to offset your mortgage payments.
However, there are several things you’ll need to consider before diving into house hacking or even buying your first investment property for that matter.
The benefits of house hacking
There are a few reasons why you might want to consider house hacking as your next investment strategy.
You could make a profit from your investment. Instead of paying rent every month, you’ll be saving money and building equity in your home.
House hacking can help lower your tax bill. By taking advantage of the mortgage interest deduction and tax breaks for landlords, these income streams can help offset any taxable income from other sources like wages or passive investments—which means bigger returns on profits!
You most likely won’t need a property management company since you’ll be living in the multifamily property yourself.
Cons of House Hacking
One of the cons of being a house hacker is that con is that you’ll need to be comfortable living on-site with roommates in your primary residence. You may want your own living space or think it’s too much of a hassle. However, if you’re willing to live with roommates, this isn’t really a con at all!
How to successfully house hack a property
If you want to successfully house-hack a property, there are a few things you must do.
Buy a duplex or triplex. If you’re only looking for one house, then the market is going to dictate what kind of home you’re able to buy in your area. But if you’re willing to purchase two or three homes at once, then there are more options available to you and thus more flexibility in terms of location and price points (since they’ll be linked together).
Cross-collateralize loans on all properties before buying them. This means that instead of having each property individually financed by different lenders and having separate monthly payments on each loan (which can cause headaches), let’s say we get a 30-year fixed rate mortgage with 20% down ($200k) on our $500k duplex/triplex combo deal ($250k combined).
Then we’ll apply for another 30yr fixed rate mortgage using our first loan as collateral for the second loan.
Develop a house hacking strategy
Develop a house-hacking strategy that will generate passive income or help pay off your housing expenses and living expenses.
Before you even start searching for a property, you need to get pre-approved for a mortgage by your bank. This will allow you to find the right property that fits within your budget and avoid having to back out of deals at the last minute because you don’t have enough money for the down payment.
When you find the right property and secure financing, it’s time to put in an offer—but don’t forget about finding tenants! They’ll pay rent every month while helping cover some of your mortgage costs, which allows you to save more money toward buying another home down the line.
Set a goal for your house hack property
Do you want to live free or do you want cash flow?
If you’re looking for cash flow, then it’s easier to buy a house that can be rented out. This is because the tenants will pay the mortgage and other expenses, so all you have to do is keep the place in good shape and collect rent payments. This can be done through online services like Airbnb or VRBO, or by doing it yourself with a rental property management company.
If you’re looking to live free, this means that you don’t need a lot of money coming in every month. You just need enough to cover your expenses (like food) and any unexpected costs (like car repairs).
The main difference between “living free” and “cash flow” is that with the former, you might actually be able to save money—whereas, with the latter, there’s no guarantee that your expenses won’t exceed what your tenants pay off each month!
Find a real estate agent who has worked with a house hack before
If you’re looking to house hack, the first thing you need is an agent who has experience with the process. This can be tricky because there are many different types of real estate agents and they don’t always have the same training or knowledge.
When looking for an agent, find one who specializes in house hacking. They’ll have more experience and knowledge about the process, plus they’ll be able to tell you if it’s right for you or not.
Purchase a multifamily property – typically a duplex or triplex
There are a few different ways to get into a house hacking situation. You can buy a duplex or triplex, which are fairly common but depending on where you live you may be able to find a single-family house that has two or more units.
For example, let’s say you live in the Bay Area and want to buy a house at the bottom of your local market cycle.
The average price for homes there is about $900k, but if you find one for $500k it could still be profitable even after taxes and mortgage payments (not counting rehab costs).
If we assume repairs will cost around $100k then your profit would be $400k after 10 years of renting out both units at market rate ($1k/month each), assuming appreciation holds steady at 5%.
You could also convert your existing duplexes into triplexes by adding an extra apartment above each unit; this would give them some breathing room while also increasing their occupancy potential
Here’s how house hacking works in practice
Here’s how house hacking works in practice. Let’s say you buy a duplex for $300,000. You secure an FHA loan from the bank for $240,000 and put in a down payment of $60,000 yourself (or from family or friends).
The first tenant pays off the mortgage on their unit, so now your tenant is paying rent toward paying off your first mortgage with them.
That leaves you with one empty unit that still has some debt on it but not too much—so now you can get another tenant!
This process repeats itself over and over until all the mortgages are paid off and then you’re left with rental income from both units instead of just one!
Next, you take out a conventional mortgage on the same property
Next, you take out a conventional mortgage on the same property for another $60,000 — also known as cross-collateralization — and use this money as your down payment.
This is a way to get more money out of the same property and into your pocket from day one. If you have a house that is worth $300,000 and you can get a conventional mortgage for $240,000 then you will have $60k in equity on day one!
This strategy works best when using private lenders who offer 100% financing (i.e., no down payment).
How much money do you need to house hack?
For this method to work, you need to have a down payment of at least 20% of the purchase price to avoid paying a mortgage insurance premium (PMI). In addition to your down payment, you’ll also want to consider closing costs and repairs.
The housing cost and all associated expenses are going the be the biggest determining factor in whether you’re cash flow positive or not, which is why it’s so important to know what your total monthly payment will be.
Work with a mortgage broker and multiple lenders to ensure you’re getting the best deal. All house hacking strategies and real estate investing depend on you getting a good deal on the purchase price and mortgage.
You can make money from house hacking by renting out rooms in your properties or by renting out other parts of the property (such as a garage).
Either way, it’s smart to have enough cash on hand so that you can pay expenses if needed during those first few months.
If you’re buying an investment property with a mortgage instead of paying cash for it outright, then your lender will expect that you have enough money saved up for taxes and insurance each year.
Do I Have To Pay Income Taxes On My House Hacking Income?
If you’re wondering whether or not your house hacking income is subject to income taxes, the answer is yes. You’ll have to pay taxes on the rent you collect from your tenants, but only if that money constitutes taxable income for you.
The good news is that the government does provide some relief for house hacking, such as not having to pay self-employment tax on your house-hacking income (which would add up quickly when your expenses are considered).
The bad news is that when it comes time to file your annual tax return and report all of these earnings, they’ll be subject to ordinary income tax rates in addition to any state and local taxes where applicable.
Calculating expenses when house hacking
A common question we get from our readers is: “what should I be spending on my house hack?” While it’s impossible to put a number on it—you should tailor your expenses to your unique situation—here are some general guidelines to help you get started:
Housing costs – This is the largest expense of your house hack. Unfortunately, there’s no way around it—you have to pay rent or a monthly mortgage payment. But take comfort in knowing that this is the one expense that will actually help you save money in the long term! You’ll be paying less than market value for your housing, and you’ll have more cash left over at the end of each month.
Housing expenses – utilities (including internet): Utilities can vary widely depending on where you live, but generally speaking, they’re going to be slightly higher than what you’d pay if you rented an apartment. However, since you’re not paying for rent or mortgage as well, this shouldn’t be an overwhelming expense.
Cleaning supplies – If you’re going with a traditional house hack and living like an adult, then yes—you need cleaning supplies. But don’t worry about buying an expensive vacuum cleaner or anything like that.
Repairs or maintenance – calculate the cost of repairs or maintenance needed on your rental property in order for it to stay in good condition and hopefully cash flow (think roof repair or replacing appliances).
Expected rental income – There are many ways to calculate expected rental income, but the most basic is this: take the rental real estate income and subtract your expenses. This will give you a rough estimate of what your rental income might be.
Here’s an example: if you want to rent out a house that costs $1,000 per month—and assuming it has three bedrooms, two bathrooms, and a garage—the monthly expenses would likely be somewhere between $180-$200 (for utilities). This means that if you charged $1,200 per month in rent, then you could expect to make anywhere between $120-$140 per month in profit.
How to find the right tenants
Finding tenants for your house hack can be a stressful experience. There’s so much to consider: will they be a good fit? Will they pay the rent on time? Will they disrupt the neighbors?
You’re probably thinking, “Surely I’ll be able to tell just by looking at them if they’re going to be a good fit!” And while you may have a good eye for character and personality, there are some things that you can’t see—like how they’ll treat your space and whether they’ll take care of it.
The good news is that there are steps you can take to make sure you’re finding the right people for your property. Here are some tips for finding tenants who will treat your property like their own:
To find the right tenant, start by asking yourself some questions. What kind of person do I want to live here? What kind of lifestyle will they bring to this home? What kind of personality will make them a good fit for this house? Will they create an environment where I want to come home after work every day?
Once you’ve answered those questions for yourself, it’s time to start looking for people who fit your vision. You can browse through listings on Craigslist or other sites, or post an ad on social media like Facebook or Twitter. Don’t forget about word-of-mouth: if someone tells you about someone they know who is looking for a place in your area, ask them if they’d be willing to share information
Find out what type of tenant profile your property attracts.
Is there a specific demographic that tends to rent in your area? If so, what are their financial situations like? What kinds of jobs do they have and how long do they stay at them? You’ll want to know this information so that when you’re interviewing potential tenants, you can get an idea of whether or not they’ll fit into your community or disrupt it in any way.
Create a list of questions to ask potential renters during interviews (and check it twice!). Ask questions about why they want to rent your space. This will give you an idea of how well they’ll fit in with other people in the area, which can be important if you’re renting out an entire house or apartment instead of just one room. If they seem like they’d be good neighbors and friends with others who live nearby, then this might be a good match for your house hack!
The tenant is the lifeblood of your house hack, and it’s vital that you find the right one.
Common house hacking mistakes
Buying a fixer-Upper home that needs too much work – Buying a house that needs a lot of work can be stressful, and even more so if you’re also trying to fix up the home yourself. Make sure you’re prepared for the responsibility that comes with purchasing a home that needs major renovations by doing proper research beforehand.
Incorrectly calculating cash flow and net operating income.
Overestimating what tenants pay and underestimating housing expenses.
Not factoring in property taxes.
Not taking advantage of their FHA and VA loans. VA loans are reserved for veterans but FHA loans (Federal Housing Administration) are perfect for house hackers and can offer benefits over a conventional loan.
Not paying attention to zoning ordinances and local laws that hinder your plans for forced appreciation. For instance, if you plan to build a spare room or separate entrance to add additional units you’ll need all the proper permits before you even begin, which can take up to a year sometimes.
Not taking landlord duties seriously – It’s easy to get carried away with the excitement of owning a property and forget that you’re also responsible for keeping it in good condition. This can lead to neglecting things like maintenance, repairs, and cleaning—all responsibilities that come with being a landlord.
The best way to avoid this issue is by working closely with your tenants. Make sure they know what’s expected of them and set clear expectations for themselves. If you want them to take care of certain repairs or report issues right away, make sure they understand why that’s important for the long-term viability of their home as well as yours (and theirs).
Conclusion
House hacking can be a great real estate investing strategy if you have multiple bedrooms and short term rental laws don’t prohibit you from renting them out.
When you have tenants paying rent to live in either half of the duplex, your mortgage is paid off by their rent checks each month.
If your tenants are paying enough rent each month to cover your mortgage plus all the other monthly costs of owning your home (more on those later), then you don’t have to pay anything extra toward your loan at all! One hundred percent of your mortgage can be paid by your tenants.
As you can see, house hacking is a great way for real estate investors and property owners cut living expenses or get more out of their existing property.
It’s also a good way to get into the real estate market as someone with a low credit score or no credit history at all. If you have some savings and can afford your current rent payment, this may be an option worth considering!
As you can see, house hacking is a great way to save money on housing costs and invest in real estate. The concept of house hacking is simple: You buy a small multifamily property with the intention of living in one unit and renting out the other units to offset your expenses. But there are many different ways to do this, so it’s important that you do your homework before buying into this strategy.
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