What is House Hacking?
House hacking is a way to start investing in real estate with minimal risk and upfront investment. When you house hack, you use your own home to earn extra money, typically by renting out a spare room or separate unit. In this guide, you’ll learn how house hacking works and different strategies to help you get started.
- House hacking involves renting out parts of your house to reduce living expenses and generate income.
- Common ways to house hack include renting out a room in your home or buying a multifamily property.
- The right house hacking strategy depends on your financial situation, goals and lifestyle preferences.
What is house hacking?
House hacking involves earning extra income by renting out a room or unit in your primary home. A common way to do this is with a duplex or multifamily property, since you can live in one of the units and rent out the rest. Alternatively, you can rent out vacant areas of your home, like a finished basement or spare room. Often, the rental income you earn from house hacking could be enough to cover your mortgage payment.
House hacking pros and cons
Pros
- You’ll cut your housing costs. House hacking allows you to share your housing expenses with tenants and, in some cases, their rent payments could even cover your mortgage payment completely. That frees up room in your budget to boost your savings, make larger debt payments or achieve other financial goals, like buying an additional investment property.
- You’ll learn about real estate investing. You can think of house hacking as an entry-level point to real estate investing. You get to gain experience managing tenants and being a landlord without biting off more than you can chew. From there — if you choose — you can scale up to bigger properties with more units.
- You may receive tax benefits. As a landlord, you may qualify for specific tax deductions, which may include property taxes, repairs and depreciation. Working with an experienced accountant (who’s familiar with real estate tax law) can help ensure you claim all of the deductions you’re eligible for.
Cons
- You’ll have more responsibilities. Once you rent out part of your home, you’re no longer just responsible for your own needs. If an appliance breaks in a tenant’s unit, you’re responsible for repairing or replacing it. You’ll also need to be familiar with housing law and set up a system to collect rent payments.
- Your rental income is taxable. Just like you report the wages you earn from a job or as a business owner on your tax return, you must report any rental income you earn. You’ll generally report your rental income on Schedule E.
- You could face vacancies or other problems. When you have renters, there’s always the possibility that they’ll move out unexpectedly, cause property damage or create other problems. You can help reduce these risks by having a clear lease agreement, thoroughly screening applicants and keeping open lines of communication with your tenants.
Should you house hack?
House hacking can be a good option if you’re looking for a way to reduce your housing costs and explore whether the life of a real estate investor is right for you. Not only can it help you save money each month, but you’ll also build equity you can use to expand your real estate portfolio down the road. With that said, house hacking is best for those with stable financial situations and the time and patience for property and tenant management.
There are plenty of ways to house hack that don’t involve a live-in tenant. For example, if you don’t want to rent out the extra rooms in your house, you could consider renting storage space in your garage, driveway or attic. If you have a large backyard or substantial piece of land, you could also look into renting space to tiny house owners who need a place to park their homes. Just be sure to research city ordinances associated with putting other structures on the property, as well as any homeowners association guidelines.
House hacking strategies
- Renting out a room in your existing home. Perhaps one of the easiest ways to start house hacking is to rent out a portion of your current home, whether it be a spare room, finished basement or an in-law suite.
- Buying a duplex. Perhaps you’re in the market for a new home and are strategizing on how it can pay for itself, at least in part. House hacking a duplex involves living in one unit and renting out the other.
- Buying a multifamily home. Like a duplex, investing in a multifamily property will provide you with more privacy. You’ll also likely earn more, since you can potentially rent out multiple units, versus just one. Before choosing this option, it’s important to assess your financial situation and risk tolerance, since this option will likely require a higher down payment.
Example 1: Let’s say your monthly mortgage payment is $2,300. You have a finished basement that you decide to rent out for $1,000 a month. You just lowered your monthly housing expenses to $1,300. You can put that extra money toward savings, paying off debt or other real estate investments.
Example 2: You buy a multifamily home with three total units. Your mortgage payment is $4,000. You live in one of the units and rent out the other two units for $2,000 each. Your total rental income is $4,000, which covers your entire monthly payment.
How to house hack in 4 steps
1. Choose a house hacking strategy
First, decide whether you want to house hack your current home or buy a duplex or multifamily home. You’ll also want to consider whether you prefer long-term renters or more of an Airbnb or short-term rental situation.
To make the right choice, you’ll need a solid understanding of your local rental market. For example, a short-term rental might make more sense if you live in a tourist area. Your decision will also depend on your lifestyle preferences. Say you greatly value your privacy — renting out a spare room likely won’t be the best option for you.
2. Secure financing
If you decide to buy a duplex or multifamily home for house hacking, your financing options include:
- Conventional loans: If you don’t want to be locked into living in one of the units as your primary residence, consider a conventional loan. But be aware that these loans can come with extra requirements you wouldn’t see with owner-occupied financing, like additional mortgage reserves.
- FHA loans: FHA loans backed by the Federal Housing Administration (FHA) are a great option if you have a lower credit score and want to make a smaller down payment. These loans come with an extra bonus for house hackers: the ability to count rent payments from a future tenant toward your qualifying income.
- VA loans: Military borrowers have access to loans with competitive terms through mortgage programs backed by the U.S. Department of Veterans Affairs (VA). A VA multifamily loan is an excellent, zero-down loan option if you meet the requirements.
Keep in mind that investment property mortgage rates are generally higher than traditional mortgage rates.
3. Make any necessary repairs
If you bought a fixer-upper home, you’ll need to make repairs before having tenants move in. Depending on the property’s condition, this could involve cosmetic repairs, like painting walls and replacing light fixtures, or more serious repairs, such as plumbing or electrical work.
4. Find tenants
It’s important not to cut corners on this part. Invest in credit and background checks for prospective tenants, and review previous landlord references. Though it’s a bit more work upfront, it can help you reduce the chances of problems in the future.
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