What Is House Hacking?

House hacking is a way of investing in real estate; however, unlike other strategies, it involves renting part of the house or property you live in. Doing so allows you to decrease your current living costs by drawing additional income from your home — all while building equity. It’s also one of the most accessible ways to invest in real estate because, whether or not you’re a homeowner already, it doesn’t require a ton of cash to get started.

House hacking: How it works

At its most basic, house hacking involves renting out rooms or units in your primary residence. The rental income can cover some or all of the costs of owning the property, so house hacking essentially allows you to live in the property for free while still enjoying the tax and price appreciation benefits of owning your own home.

Things you should know

In the mortgage world, properties that you’ll live in full time are called “owner-occupied.”

Can you house hack if you don’t already own a home?

If you’re already a homeowner, house hacking is a fast and fairly easy way to reduce your living expenses and start building wealth nearly overnight. But what if you’re not a homeowner yet and you have limited cash flow?

The good news is that purchasing a house to hack is far easier than getting a conventional investment property loan, which would require a 15% to 20% down payment and a higher credit score.

The low barriers to entry are part of what makes this method of real estate investing so unique. Government-backed loan programs make it possible to put only 0% to 3.5% down on a multifamily home, as long as you’ll also be living there, while conventional loans allow 3% down.

5 house-hacking strategies

If your goal is to live in a house of your own for free, picking the right house-hacking strategy will be key to making it happen. With that in mind, here are five different ways to approach house hacking.

1. Rent out extra bedrooms

If you’re house hacking a single-family home, taking on a housemate or two is likely your best bet. If you have a guest bedroom or office you barely use, you can set it up as a rental. How much you can charge in rent will depend on the housing demand in your area, but you can at least offset a portion of your own monthly rent or mortgage payments.

Not ready to live with a stranger?

Consider renting a room to a family member. The number of Americans living in shared households has risen since 2007 and yet, interestingly, the most satisfying roommate arrangement is living with one other housemate who is related to you, according to survey data from ApartmentGuide.com.

2. Rent out a finished basement or in-law suite

If your house has a finished basement, in-law suite or accessory dwelling unit (ADU), it can become a great income-generating property, particularly if it’s equipped with its own kitchen and bathroom. The advantage here is that you won’t need to share those spaces while still earning passive income each month.

3. Buy a multifamily home

Perhaps you’re in the market for a new home and are considering how you might make it pay for itself, at least in part. House hacking a duplex, or another type of multifamily home, enables you to set up your own space while renting out the other unit(s). As with the in-law suite, you’ll have more separation and privacy than with a roommate.

4. Rent garage, driveway or attic space

There are plenty of ways to house hack that don’t involve a live-in tenant. For example, those who can’t or don’t want to give up any of their extra bedrooms might want to rent storage space in their garage, driveway or attic.

5. Rent out your yard

Meanwhile, if you have a large backyard or substantial piece of land, you might rent 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. This option may be best for property owners who live outside of city limits.

How to buy a home for house hacking: Loan options and requirements

When searching for a home loan that’ll enable you to house hack, your main focus should be finding a loan with reasonable costs that still leaves room for you to turn a profit.

Conventional loans

If you’re looking to buy a duplex, triplex or other multifamily property, but you don’t want to be locked into living in one of the units for a significant period of time, a conventional investment property loan may be the way to go. Projected rental income from a future tenant can help you meet the debt-to-income (DTI) ratio requirement.

Just be aware that these loans can come with extra requirements you wouldn’t see with owner-occupied financing, like additional mortgage reserves or experience with property management. They also typically carry mortgage rates about 0.50% to 0.875% higher than you’d see with owner-occupied options.

Minimum requirements:

• Credit score: 640 to 700
• Down payment: 15% to 20%
• Maximum DTI ratio: 45%
• Income limits: None
• Occupancy: You’re not required to live at the property

Rate changes for investment properties

The rates and fees you’ll pay on a conventional investment property loan have dropped by $1,500 for borrowers who are able to put 30% to 40% down. Even better, if you’re in the market for a multiunit property (two to four units), your rates and fees have decreased regardless of how large a down payment you make.

FHA loans

FHA loans backed by the Federal Housing Administration (FHA) are a great option if you don’t have stellar credit and want to make a small down payment. These loans come with an extra bonus for house hackers: the ability to count rent payments from a future tenant toward your income.

Minimum requirements:

• Credit score: 500 to 580, depending on down payment amount
• Down payment: 3.5% down with a 580-plus credit score; 10% down with a 500 to 579 credit score
• Maximum DTI ratio: 43%
• Income limits: None
• Occupancy: You’re required to live in the home as your primary residence

Good news for borrowers paying FHA mortgage insurance

The Federal Housing Administration has reduced its annual mortgage insurance premiums by 0.30 percentage points, saving the average borrower around $800 per year.

VA loans

Military borrowers have access to loans with extremely 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 have the required service experience. As with other multifamily loans (both conventional and government-backed), you’re allowed to count a portion of any future rental income toward your income when calculating DTI. However, you will also have to demonstrate some level of experience with being a landlord.

Minimum requirements:

• Credit score: No minimum set by the VA
• Down payment: 0%
• Maximum DTI ratio: 41%
• Income limits: None
• Occupancy: You’re required to live at the property as your primary residence

Go big: Borrow with another veteran

Did you know that if you join forces with another qualified military borrower, you’ll gain more buying power? While most multifamily loan programs limit you to four units, if two military borrowers go in on a property together they can use a VA loan to purchase up to seven units.

USDA loans

The U.S. Department of Agriculture (USDA) offers a unique type of financing to borrowers in eligible rural areas who want to provide housing for underserved populations. You could qualify if you want to rent to at least one of these three groups: people with low to moderate incomes, people with disabilities or senior citizens. These loans come with a lot of unique requirements; however, if you do fit the bill, you can access a 30-year multifamily property loan at a competitive interest rate through the multifamily housing direct loan program.

Minimum requirements:

• Credit score: No minimum set by the USDA
• Location: You must live in an area designated as rural by the USDA
• Down payment: 3% to 5%
• Income limits: There’s no income limit, but you must be able to show that you don’t have any other viable financing options
• Occupancy: You aren’t required to live at the property

Tip

In order to help you zero in on the right loan and property, consider using the 1% rule of real estate investing. At its core, the rule states that viable investment properties should generate enough rent to cover at least 1% of the purchase price. However, ideally, your goal should be to buy a property that will generate enough rent for you to cover your entire mortgage payment.

Pros and cons of house hacking

Pros

  You’ll decrease your expenses. If you can rent out your extra space for enough money to cover your entire mortgage payment, you’ll be free from any worries about being able to afford your housing costs.

  You’ll increase your net worth. As you use your rental income to pay down your mortgage, you’ll build home equity in the property. You can then use that home equity for a down payment on another home or finance big expenses.

  You’ll gain valuable experience. If your goal is to eventually build a bigger real estate portfolio, this’ll give you valuable experience in vetting tenants, negotiating leases and managing a property.

  You’ll form new connections. Sometimes the best part of renting out space is getting to know your tenants. In addition to the obvious financial benefits of house hacking, you’ll also have the opportunity to form new connections and make new friendships.

  You’ll have the option to refinance into an investment property loan. This will allow you to keep the home as an investment if you want to move out.

Cons

  You’ll have to cover some upfront costs. Many new investors want to learn how to house hack with no money — unfortunately, that’s not really possible if you don’t already own a home. Buying a house and getting it ready for tenants does come with some upfront costs, including a down payment and closing costs, which you’ll need to be able to afford.

  You’ll have more responsibility. Being a live-in landlord or roommate comes with a lot of responsibilities and headaches. You’ll not only have to find tenants and collect rent, but also manage any maintenance and upkeep on the property.

  You’ll have less privacy. No matter which method you choose, house hacking involves living in close quarters with other people. You’ll have to be willing to give up some of your privacy in exchange for the financial benefits.

  You’ll need to prepare for the worst. While no one likes to think about it, there’s always the possibility that your tenants will default on their rent. If that happens, you’ll need to be prepared to pick up your mortgage payments to stay in good standing with your lender.

How to avoid the pitfalls of house hacking

Like any financial opportunity, house hacking does come with some possible pitfalls.

• Forgetting to assess the market. In order for your house-hacking strategy to work, you need to collect enough rent to cover your financing costs. Be sure to assess the state of the local market before you make a purchase to verify that your property will generate enough rental income to cover your costs.
• Not checking state and local laws. Some states and municipalities have laws governing rentals, especially those that are short-term. Make sure you’re aware of and able to comply with any laws in your area before investing any money into this strategy.
• Not thoroughly vetting your tenants. Be sure to do at least a credit check, employment check and background check on each potential tenant that you want to bring into your home. Otherwise, you could end up with a tenant that doesn’t pay or causes other problems.
• Neglecting your landlord responsibilities. As a landlord, you’re responsible for certain duties, including keeping the property in decent condition. If you neglect to follow up on these responsibilities, you could find yourself with a high turnover rate — or worse, involved in a lawsuit.
• Draining your reserves. If a tenant decides to stop paying rent, you’ll need to pick up the tab while you work to evict them. With that in mind, it’s a good idea to have an emergency fund to cover those costs.

Tip

Before buying a property, find out what laws apply to rentals in the area. The Fair Housing Act — which prohibits discrimination in tenant selection — doesn’t apply to roommates, but it does apply when renting out separate units. That said, if you’re acting as a landlord, you’ll be held to strict standards regarding how you advertise the property and how you evaluate potential tenants. You’ll also be responsible for maintaining the property, so it’s best to know what laws apply to you before making a purchase.