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House Hacking: What It Is And How It Can Drastically Reduce Your Living Expenses

8-Minute Read
Published on July 16, 2021
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Homeownership offers a worthwhile way to build wealth over time. However, you can take this opportunity to the next level with house hacking. Essentially, this lifestyle strategy allows you to build wealth through homeownership while reducing your housing expenses.

Let’s explore exactly what house hacking is and how it can help you accelerate your path to financial freedom.

What Is House Hacking?

House hacking is a strategy that can transform your finances for the better. The goal of house hacking is to rent out extra space in your primary residence to create an income. The income generated can be used to offset the expenses of homeownership.

With house hacking, you can pursue a variety of potential income streams. You may decide to rent out extra rooms while sharing common areas. Or you may choose to rent out an area that doesn’t involve any shared spaces.

Depending on the property, it could be possible to cover your entire mortgage and other costs associated with homeownership. With that, it is easy to see why house hacking has become such a popular real estate investing tactic. It is an especially useful strategy for those new to investing.

The Advantages Of House Hacking

The idea of house hacking is very intriguing. It offers a creative approach to help you optimize your housing costs while building equity in a home. Here’s a closer look at the top advantages of house hacking.

  • Frees up cash flow: When you house hack, you will be collecting monthly rent from tenants who are using a portion of the property. With that, you can use those funds to cover your mortgage more quickly, which frees up cash flow to explore other investment opportunities.

  • Easier to finance: Since house hacking occurs in your primary residence, it’s easier to obtain financing than if you were investing in a property. Owner-occupied properties can access loans with lower down payments compared to financing a secondary residence. Plus, you have a chance of securing better loan rates as an owner-occupied property.

  • Creates passive income: When you have tenants in place, the newfound income stream can be relatively passive.

  • Provides tax benefits: Through house hacking, you will become a landlord. With that distinction, you can tap into certain tax benefits that rental property owners are entitled to. For example, landlords may be able to deduct rental-related expenses on their taxes.

Although these are not the only benefits associated with house hacking, these are some of the biggest ways that this strategy can benefit you.

The House Hacking Strategy In 7 Steps

Want to enjoy the benefits of house hacking? Here are the steps you’ll need to follow to implement this strategy in your own life.

1.   Choose The Type Of Opportunity

House hacking comes in all shapes and sizes – there is not a one-size-fits-all approach. With that, you can choose the opportunity that best fits your lifestyle and your goals.

  • Single-family homes: A single-family home is an easy place to start house hacking. You can rent out any extra rooms to generate an income. Typically, this option requires you to share common areas such as the kitchen or living room with your tenants.

  • Multifamily homes: Multifamily homes involve several units within the same property. For example, a duplex or triplex would be considered a multifamily property. With this option, you will not have to share any indoor spaces with tenants. But a multifamily property can be more expensive to obtain than a single-family home.

  • Spare rooms or finished basements: A spare room or finished basement is the perfect space to rent out to tenants. If you have available space in a property, consider whether it is a possible income stream.

  • Accessory dwelling units (ADUs): An ADU is a separate building on your property that could be rented to tenants. The added privacy offered by an ADU provides an option for house hackers who don’t want to share common spaces with their tenants.

  • Vacation rentals: Depending on your area, converting your homes into a short-term rental through Airbnb or Vrbo can be a lucrative opportunity. Although there is more work that comes with the higher turnover rate, it could be worth the rewards.

2.   Conduct Market Research

Before you dive into homeownership with the assumption that you can cover your entire mortgage, take some time to conduct market research. You should look at the property values in the area, consider how much you could expect to earn from renting space to tenants, and estimate the amount of mortgage you can realistically afford.

It is important to be realistic in your mortgage expectations. Remember, house hacking is a great option. But there will likely be months of vacancies, which means that you’ll need to pick up the entire mortgage payment. Don’t overextend yourself.

Take a look at our guide to the best cities for real estate investing to start your research.

3.   Do The Math

The math behind house hacking can be a powerful way to transform your financial future. Here are some of the numbers that you should keep in mind while exploring a potential house hack:

  • Net Operating Income (NOI): Net Operating Income can help you calculate the potential profitability of a real estate investment. Essentially, you simply subtract all of the general expenses of maintaining the property from all of the income produced by the property. As a house hacker, you can use this to understand the profitability of a potential deal.

  • Cap rate: The cap rate, also known as the capitalization rate, puts the profitability of a property into the context of the purchase price. With that, you can weigh the income you can potentially produce through a property against the upfront costs of purchasing the property. As you consider your house hacking options, a higher cap rate will reflect a higher risk associated with higher rewards.

  • Cash flow: The cash flow generated by a property can be determined by subtracting your monthly housing expenses from the income generated. As a house hacker, the goal is to reduce your monthly housing expenses. In some cases, you may be able to break even or even produce a positive cash flow. But in other cases, you may be happy with a negative cash flow that still allows you to reduce your housing costs.

  • The 1% rule: The 1% rule is a common way to look at deals in real estate investing. Essentially, you want the monthly rent to be at least 1% of the purchase price. If you are a house hacker, you can consider the market rental price of your unit in this calculation to determine if the property follows the 1% rule.

  • Estimated monthly mortgage payments: A monthly mortgage payment is an unavoidable expense as a home buyer without the capital to purchase a home in cash. With that, it’s important to understand the costs of your mortgage before diving into the deal. Although an exact monthly mortgage payment can be difficult to calculate ahead of time, you can use our mortgage calculators to get the best estimate possible. As a house hacker, you’ll want to know this number ahead of time to see how much you should expect to cover in monthly housing expenses.

4.   Shop Financing Options

One of the biggest misconceptions about investing in real estate is that people assume down payment requirements are similar to that of an owner-occupied home purchase.

When you purchase a home for yourself, you have the ability to use owner-occupied mortgages such as VA loans or FHA loans. These allow you to close with 3.5% down and in some cases 0% down.

However, when you purchase an investment property that you don’t plan to occupy, most lenders require at least a 20% – 25% down payment. By purchasing a primary residence and renting out a room/other units, it will give you access to lending options that may otherwise be unattainable. This gives you access to lending options not available to most investors.

One thing that you can do is rent out your home through Airbnb or another short-term rental company. You’ll need to provide your most recent tax return including Schedule E. Additionally, you’ll need a host report for the last year. With a HomeReady® loan from Fannie Mae, income from a long-term border who also lives in your primary home may also be used to qualify.

As you consider your financing options, take the time to shop around for the best deal.

5.   Consider Your Limitations

House hacking provides an opportunity for home buyers. However, there are some limitations associated with this strategy. Not every HOA or local municipality is friendly to house hackers. An HOA or municipality could limit your ability to rent out space to tenants.

Additionally, some housing markets have a low demand. With that, you may struggle to find tenants. As you explore house hacking as a strategy for your life, consider what obstacles may exist in your unique situation.

6.   Renovate And Repair

When you close on a property, it is important to renovate and repair the spaces you plan to rent out. Although you may be totally fine with an outdated space, the best tenants will be looking for a better space.

If you take the time to create a welcoming space for future tenants, you can maximize your return on investment.

7.   Find And Screen Tenants

The success of your house hacking strategy will depend on the tenants you find. Without tenants paying rent, you will simply be a regular homeowner. However, not just any tenant will do. Many new house hackers rush to fill the unit with any tenant who applies. But that can lead to a disaster down the line.

With that, it’s important to screen tenants before they move into your home. The process of screening can be as involved as you want it to be. But it’s critical that you have some form of screening in place to work with tenants who will be a good fit for your space. A few common steps include hiring an agency for background checks, running a credit check, and verifying the income of a potential tenant. Once you have found a tenant who passes your screen, you should draft an official lease. Make sure that the lease is signed before the tenants move into your space.

Although finding good tenants is the key to success for most real estate investors, it’s essentially important for house hackers. The tenants you choose to work with will be sharing the same property as you. With that, you want to make sure you find a good fit upfront to save yourself a headache down the line.

Other Considerations

House hacking is a great way to optimize your housing expenses. However, it doesn’t come without a bit of work.

Like all real estate investors, you’ll be facing the obstacles of maintaining a property. Whether you choose to hire a handyman or do the work yourself, it can be a challenge to stay on top of everything. Beyond the responsibilities of a regular landlord, house hackers have an added level of responsibility because they live next to their tenants.

If you’re concerned about handling the logistics of house hacking, you could consider working with a property manager to make things flow more smoothly. Hiring a property manager can cut into your profits. But it might be worth it to you.

The Bottom Line: House Hacking Is A Beginner-Friendly Way To Start Real Estate Investing

As a first-time real estate investor, house hacking opens the door to the opportunities you’ve been waiting for. The appeal of owner-occupied financing will allow you to get your first rental property online faster than you thought possible.

Take some time to do your research before choosing to pursue the house hacking strategy. Although there are some pitfalls, the benefits are overwhelmingly positive. Ready to start searching for the perfect house hacking property? Take a look at our top tips for buying an investment property. Feel free to apply online!

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Sarah Sharkey

Sarah Sharkey is a personal finance writer that enjoys helping readers learn more about their finances. She has an MS in Business Management from the University of Florida. You can connect with her on LinkedIn or Instagram @adventurousadulting.