House hacking is when an owner lives in a property and slowly improves it over time. They might rent units in the property so the tenants cover the mortgage when they make improvements, increasing the property value.
House flipping, something that became extremely popular in the last few decades, is a form of house hacking. Some people might buy a house and, after living in it a while, they might purchase another home to live in while they rent out and improve the first property.
No matter how you handle house hacking, the goal is to increase the value of the property so you can rent it for higher rates or sell it at a profit. The advantage of living in the property you’re hacking is that you can sell it with no tax burden because it’s considered your primary residence.
- How Does House Hacking Work?
- What are the Benefits of House Hacking?
- How to Get Started with House Hacking
- Avoid These House Hacking Mistakes
- Short-term or Long-term Rental?
- A Few Final House Hacking Tips
How Does House Hacking Work?
House hacking is any situation where you buy a property and fix it up while living in it.
The best way to house hack is with a multi-unit property. You might call it rental hacking too.
In this situation you live in one of the units and rent out the other ones. Ideally, the renters pay enough to cover the cost of the mortgage so the owner lives for free. This is the best method of house hacking, though there are other ways of reducing the cost of living, such as turning a space of your home into an Airbnb.
There are plenty of creative ways to house hack, so if it’s something you are considering you have plenty of options.
What are the Benefits of House Hacking?
Most homeowners spend more than 30 percent of their income on their mortgages each year. Many spend far more than 30 percent. Reducing or eliminating mortgage payments is one of the fastest paths to financial freedom because it provides for so much in savings. Shifting your mortgage obligations to renters also frees up money to improve your property and increase its value.
Some of the benefits of house hacking include:
- Reducing or eliminating your mortgage costs, maybe more. This is the biggest benefit and the reason why most people try house hacking. You might have to pay more upfront to get a property that’s right for hacking but once you’ve rented out the units, it quickly pays off.
- Gaining flexibility and making the most of your life. House hackers are often creative go-getters. They want to make the most of their investment dollars and tend to be adventurous. House hacking provides plenty of flexibility and doesn’t lock you into a traditional long-term living situation.
- Eases you into investing in property. House hacking is a great way to gently enter the world of property investing and rentals. Living onsite helps you become a better landlord which helps you in the future if you choose to do this full-time. Your property will also be viewed as more appealing to renters because they’ll never need to worry about tracking down an absentee landlord – you’ll be living right there with them!
- Provides a passive income stream. House hacking gives you extra cash flow but doesn’t require you to commit to a full-time job. Yes, you’ll have obligations as a property owner and landlord but most of these can be met on a single property while working full-time elsewhere. Look at it this way: if you’re going to own a house and have all the responsibility of doing so anyway, you might as well look for ways to reduce the cost.
House hacking is one of the fastest paths to financial independence. It can help you get there faster than the average person and makes it possible to lighten the load of the normal financial burdens many people face. It can also be a lot of fun.
How to Get Started with House Hacking
If house hacking seems like something you’d like to try, there are three basic ways to prep for becoming a successful house hacker:
Determine Your Financing
There are many financing opportunities available to owner-occupants that might not be options for real estate investors or single-family owners. As long as you plan to live in the property you’re renting, you might qualify for bank loans with attractive terms and lower payment options. For example, FHA loans are available for multi-family properties with at least four units. These loans require only a 3.5 percent down payment so you can get into a property without spending years saving.
There is also the Buy, Rehab, Rent, and Refinance or BRRR option. You use short-term funds to rehab and rent the property and then refinance for a long-term mortgage with more favorable terms. This gets you into the property and allows you to get renters established before you need to focus on a long-term loan.
Choose the Best Property
Once you have financing lined up or a general idea of where you’re getting it, it’s time to find the best property for hacking.
It’s important to approach the purchase of your hack property as a rental property owner as opposed to someone buying a family home. Approaching the process with more of a business mindset helps you make smart purchasing decisions without allowing your heart to take over.
Factors that are important when shopping for a home for hacking are location, population growth, nearby job opportunities, and local amenities.
Keep in mind that you aren’t shopping for a home for yourself, you’re looking for a property that suits the needs of other people, too – and you aren’t entirely sure who those people are yet. This means getting to know your local renters market and understanding what today’s renters are looking for in their homes.
Crunch the Numbers
Now that you’ve chosen one or more properties you’re interested in, you can get down to business. You need to crunch the numbers and run a deal analysis to find out whether the property is a smart investment.
Start by estimating your rental income and the cost of property upkeep to get your Net Operating Income (NOI). In this calculation, include the rental income for each unit, property taxes, insurance, maintenance and repairs, utility costs if you aren’t including them in rent, and vacancy reserve.
Subtract your estimated monthly mortgage payment from the NOI to figure out your monthly cash flow. This is what’s left over after expenses and what can be invested into the property or other investments or savings.
Positive Cash Flow
This number should be positive and the bigger it is, the better. Remember, though, even if you break even, you’re still saving because your mortgage payment isn’t coming out of your pocket.
Take a good look at whether these numbers work for you and your financial goals. This is an essential part of making a smart decision when it comes to house hacking and determining whether it’s something that is right for you.
Avoid These House Hacking Mistakes
There are several mistakes to avoid if you choose to pursue house hacking. These mistakes can cost you money and ruin the experience so make sure you familiarize yourself with what not to do before you get started.
Choosing a Less-than-Appealing Neighborhood
You might be able to find a great deal on a property in a less-than-desirable neighborhood but you may struggle to find renters. Many people invest in low-income areas where homes need upgrading which can be a great investment opportunity but if you’re planning to hack, you need to buy in an area where it’s easy to attract tenants. You should also make sure it’s an area where you want to live since you’ll be onsite.
Disregarding Local Ordinances
If you’ll be upgrading or altering the home in any way, make sure it’s zoned properly. Some communities don’t allow multi-unit homes or frown on renters. Though irritating your neighbors might be a small price to pay for a great investment, you can’t overstep and violate local laws or regulations.
Not Adding the Cost of Repairs into Your Budget
Make sure you account for all costs when estimating your expenses and set money aside for repairs and unexpected expenses. If you don’t, you might find yourself in a money pit pretty quickly. All homes, no matter the arrangement, have things go wrong and need emergency repairs. When you’re renting, you have very little flexibility in taking care of those repairs. Having a budget for the unexpected is an essential part of hacking success.
Failing to View Yourself as a Landlord
If you find yourself saying “oh, I’m just living here and renting to people temporarily, but I’m not really a landlord,” you need to take a step back. You ARE a landlord and you need to take it seriously. Even if you’re friendly with your renters and house hacking part-time, you need to be professional. Set clear and enforceable boundaries and establish a system for dealing with tenant issues. This is especially important because you are living on site.
Carefully screen tenants. Evict them according to the law, collect rent according to the law, and deal with issues that arise as any other professional landlord would. Failing to take your landlord duties seriously can result in significant financial damage and might lead to legal action.
Short-term or Long-term Rental?
It’s possible to rent to people short-term or long-term or part-time or full-time when house hacking. You have the option of renting full-time or part-time and to do it for long- or short-term rentals.
You can also do a combination, for instance, you might consider renting to college students for the semester or the year. Also, you could rent a room overnight or for a few nights at a time and operate it as an Airbnb. You can rent to traditional renters with one-year leases or people traveling for business for a week or month at a time.
A Few Final House Hacking Tips
There are a few things to do before jumping into house hacking. While it can be the greatest financial investment of your life but only if you go about it the right way.
Before you begin, make sure your credit is in order. Check your credit report for errors and if your credit isn’t in the best shape, spend a few months or a couple of years to improve it. Be sure not to apply for any credit cards or do anything to negatively affect your credit in the weeks and months leading up to launching your house hacking journey.
Assess properties realistically when house shopping. You might love a place but if there is too much work to do, the place is a money pit and you should avoid it. Have a professional assessment done of any home you are considering and use your mind – not your heart – to guide your buying decisions.
Now What to Do?
If you’re willing to invest the money and time into doing house hacking properly, it can help you pay off a mortgage early and reinvest your cash flow in many different ways. Even if your goals aren’t that lofty, house hacking can help you make mortgage payments more affordable and give you more money to do things you love. You can enjoy life while still reaping the benefits of homeownership.
Regardless of why you want to house hack, it can be a beneficial experience. If you’d like to know more, sign up for our email list.