House Hacking 101
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photo by brian babb
In recent years house hacking has become more commonplace, as the number of folks who are interested in owning a home while fast tracking their investment position increase. House hacking is a way to generate income from the home you use as your primary residence. There are several upsides to house hacking, but the primary ones are; offsetting the cost of the mortgage and maintenance costs of owning a home, greater personal and financial flexibility, and long term wealth growth.
The What, Why, Who and How of it
What: House hacking is the process of owning a property and renting a room or multiple rooms in a single residence, or by renting an additional unit or units in the case of owning a multi-unit building.
Why: This is one pathway into homeownership or real estate investing. It is attractive for a variety of reasons depending on the homeowner and their situation. Some folks are simply looking for a way to offset the cost of home ownership while others may be looking to create more freedom in their lives.
Who: House hacking is for anyone who is looking to step into home ownership or real estate investing and wants to offset the financial burden of their mortgage and housing costs, while further leveraging their financial position.
How to finance:
The all-in costs will largely depend on the cost of the home, the amount of the down payment, whether the home requires upgrades or renovations before occupancy, and if there are current renters on premise when the property is purchased.
A typical non-owner occupier/investment loan requires a higher percent down payment, to the tune of about 25 percent. Since house hacking is an investment method for owner occupied properties, the loan types and down payments options tend to offer more attractive terms. Another thing to note, if you’re purchasing a multi-unit property with an active lease a percentage of the rent received can be used toward qualifying for the mortgage.
Again, house hacking is for those who are purchasing the property as a primary residence, here are a few categories of loan types:
Conforming loans: These loans fall under specific guidelines allowing for purchase eligibility from Fannie Mae and Freddie Mac and can often be found with downpayments as low as 3% of the purchase price of the property.
Conventional loans: Conventional loans are not guaranteed or insured by the federal government. These types of loans most often require 20% down payment, however some can be found with downpayments as low as 3% of the purchase price of the property, though eligibility is based on the borrower’s personal financial situation. If less than 20 percent is put down mortgage insurance, which protects the lender in case of default, will be required.
FHA loans: FHA loans are backed by the Federal Housing Administration (FHA) and generally the requirements for approval are less stringent compared to conforming and conventional loans. The down payment amount can be as low as 3.5% of the purchase price of the property. Private mortgage insurances (PMI) will be required until you reach a higher amount of equity at which point you can refinance so that you no longer have to pay this.
VA loans: VA loans are for veterans, active military, and surviving spouses. These loans do not require a downpayment minimum or mortgage insurance.
USDA loans: These loans are backed by the United States Department of Agriculture. It is not necessary to purchase farm land or in rural zones to utilize, however specific areas restrictions do apply as well as income limitations.
State run or local programs: In Colorado we have some options for borrowers. For instance, the Colorado Housing and Financial Authority CHFA offers primary home loans and grants, and second mortgage home loans to assist with down payment and closing costs.
Common House Hacking Scenarios
Multi-unit building: utilize one of the units as your primary residence and the other unit/s will be rented to provide rental income.
Single family home: provided there is an extra bedroom or two, use these spaces for roommates.
Single family home: utilize a basement or additional living space that is, or can be, outfitted with bathroom and kitchen/ette to function as a separate unit.
ADU: consider a property with an existing accessory dwelling unit (ADU) or the capability for an ADU. ADU’s most often function completely independent of the primary residence with its own entrance and complete living spaces. It’s important to check with the city and county you live in to understand how, if, and where, ADU’s are permitted.
Short term rental: It is considered a short term lease for an occupancy of thirty days or less. It is important to check with the city and county to understand the rules and regulations of short term rentals in your area.
Benefits Of House Hacking
Mitigate housing costs: Offset the cost of the mortgage and other home ownership expenses with the income from the rents received, and perhaps create cash flow. Cash flow is the amount of rental income in excess after the principal, interest, taxes and insurance (P.I.T.I.) are paid in full. It is always smart to put money away for maintenance expenses as well.
Equity gain: holding the property over the long term allows the property to increase in value. The equity can be tapped at a future date depending on the situation and strategy of the property owner.
Wealth creation: procuring a property-asset that generates income allows you to pay down the mortgage quickly or save to purchase another property or different type of asset to add to your personal investment portfolio.
Flexibility: personal flexibility is granted to homeowners with an evolving lifestyle who have the ability to shift as they need to. Additionally, there is greater financial flexibility as the burden of the entire mortgage is lifted by incoming rents.
Risk management: by utilizing the rental income received the property owner naturally is put in a position of greater personal economic safety.
Getting Started Pointers
Avoid undesirable neighborhoods: If you don’t want to live there chances are others won’t want to either. Choose an area that attracts strong rents and quality tenants.
You’re a landlord now: take this role seriously, treat others as you would want to be treated and maintain the residence. Also, safeguard yourself and your asset by understanding your local rules and regulations pertaining to being a landlord and utilize a written lease contract.
Smart budgeting: it is wise to put a portion of the rental income received into a maintenance account for capital improvements or expenditures ie: for a furnace replacement. Best to have funds readily available, if you don’t this could disrupt tenancy and tarnish your reputation as a landlord.
Local rules and regulations: understand and follow the local rules and regulations pertaining to property zoning, ADUs and short term leasing, being a landlord and so on. If you choose to go against the law legal action could be taken or there could be a negative impact on the value of the property.
Analyzing Basics
Know the neighborhood: do your homework on the neighborhood you plan to live and invest in. Know the upsides and the downsides, and its overall trajectory from a property value perspective.
Rental potential: know the numbers based on the investment situation you want to create; rent by the room, unit rental based on size and bedroom count, or short term rates. It’s also very useful to understand average annual rental rate increases in order to capture upon lease renewal or turnover.
Property expenses beyond the mortgage: Consider capital improvements, maintenance costs, vacancy, and perhaps a property manager.
Have your A-team identified: use the help of professionals in the industry. Find an experienced real estate agent and have a go-to lender who knows your goals. Additionally, getting resourced with a property manager, contractor and subcontractors, real estate attorney and tax advisor are all important.
House hacking is just one avenue into home ownership and real estate investing. It can help you pay down your mortgage quickly, giving you flexibility to pursue other interests or investments, and is one pathway to build wealth. If you are curious about house hacking or want to analyze a property, reach out.