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Originally Posted On: https://fibyrei.com/house-hacking-ultimate-guide/
House hacking is an easy way to accelerate your savings rate quickly. If you are like most people, your housing costs represent a large portion of your expenses. House hacking offers a way to slash your housing costs simply by becoming a savvy homeowner that maximizes the utility of your property. You can even use house hacking to wade into the waters of real estate investing if this is of interest. You have the opportunity to build your portfolio and your knowledge base through house hacking. If you are ready to start house hacking, then dive into our complete guide below. We break down exactly what house hacking is and how you can start using this FI strategy.
What is house hacking?
The idea of house hacking is very simple. It is to reduce or eliminate your housing costs. It is all about being creative with your housing choices. Most folks do this by simply renting out any space that you aren’t using to cover the mortgage. Although the type of space you rent out varies, the goal of covering your housing costs remains the same.
Here are the six main ways to hack your housing, each with their pros and cons:
1) Room Rental
Renting out a room in your house is a straightforward way to house hack. You can rent out the extra rooms in your house to long term tenants or short-term vacationers through Airbnb to cover your housing costs. In this situation, you would likely share common areas with your renters. You might need to get used to the idea of sharing the kitchen and living room with others. If you already have a single-family home, then this is an easy way to get started.
2) Converting Your Existing Space For An Income Suite
If your current housing situation doesn’t have any extra rooms, then you could convert or modify the space you have. Consider adding a mother-in-law suite or finishing a basement to create extra livable space to rent out.
Modifying existing space gives you more control over your house hack. You could create a space to maximize privacy for yourself and your renters or leave it more open. You’ll need to think about this in terms of your personal preferences. Another benefit of converting existing space is, it can add value to your home. An example is when you take that unfinished basement, and make it livable space, that is directly increased the livable square footage which increases your home’s value.
3) An Accessory Dwelling Unit
An accessory dwelling unit, or ADU, refers to another building on your property. You can rent out this separate building to cover the cost of your total mortgage. A few options might include converting a pool house or adding an apartment above your garage. If you already own a property that has extra space for an additional building, you will need to spend money to build and have to get approval from the zoning department in your city or county. This can be time consuming and expensive. The other alternative is if you are looking for a new home, look for homes that have an existing ADU that can be renovated or modified.
4) Small Multi-Family Building
In this scenario, you would buy a small multi-unit home and rent out the extra units. For this type of house hack, you can only buy a building with up to 4 units to ensure owner-occupancy financing benefits. For example, you could buy a duplex and rent out one side. It is a great way to maximize privacy while enjoying the benefits of a house hack.
Bonus Tip: Combine this style of house hacking with a room rental house hack. An example is you buy a duplex that has two bedrooms and one bathroom on each side. You rent out the other side like you normally would. Then for your side, you live in one room and rent out the other room to a friend.
5) Slow Flip
If you don’t want to be a landlord but still want to house hack, you have options. The slow flip option means that you will buy a fixer-upper and live in it while you flip it. Typically, you’ll live in the house for at least 1 year while you fix it up. After you’ve made the house an inviting home, you can sell it for a profit and move on to your next house.
Bonus Tip: If you live in the home for at least 12 months and then sell you don’t have to pay any capital gains tax if the growth in appreciation is less than $250,000 for a single individual or $500,000 for a couple. Whereas most home flippers sell a home they renovate in less than 12 months and most of the time in less than 6 months, and they pay regular income tax on their profit.
6) Work Provided Housing
Work provided housing is the lowest maintenance house hack option. Essentially, you find a way for your employer to pay for your housing. You might be surprised to learn that many employers offer free or subsidized housing to their employees. Find out if your employer offers this amazing option!
If you are interested in finding out more about these opportunities, then check out our podcast for case studies.
Why Should You Consider House Hacking?
After taking a look at the different ways you can house hack, you might be wondering if the reward is worth the effort. If you choose to house hack, the decision will almost definitely benefit your financial future.
Supercharge Your Savings
With soaring housing costs around the country, it is not uncommon to pay thousands of dollars each month in order to live in your home. According to The Bureau of Labor Statistics, Americans spend 32.8% of their income on housing each year. Although housing costs vary around the county, the costs can add up quickly in any budget.
Take a second to imagine the impact of eliminating or significantly reducing your housing costs. You could use those newfound savings to build your nest egg at a fast pace, pay off student loans, buy that new car you have always wanted, or take that dream trip.
Learn to be a Landlord
Not everyone wants to be a landlord and real estate investor, and that is ok. But if you want to learn about real estate investing, Real estate investing can be a successful path to FI. However, the idea of being a landlord can seem overwhelming to new real estate investors. Instead of allowing your fear of being a landlord to prevent you from investing in real estate, you can use house hacking to start your real estate journey.
With a house hack, you will be an onsite landlord as you learn how to successfully manage tenants. It can be a great first step into the seemingly murky waters of being an effective landlord.
Owner-Occupants Get Better Financing
Since you will be living in the property, you will have access to owner-occupant financing. The financing terms offered to owner-occupants are typically more favorable than non-occupant terms. In order to secure owner-occupant financing, the property cannot have more than 4 units.
One of the perks of owner-occupant financing is the ability to put down a smaller down payment. Depending on the loan you choose to pursue, you may only need to but 3.5% down. If you bought a $150,000 property to house hack, then you may only need to come up with a $5,250 down payment. Whereas if you compared to buying the same $150,000 property as a pure rental property you would have to put 20% down, that is $30,000.
As you can see, owner-occupant financing lowers the barrier to buying a property.
Learn the Ropes of Real Estate
If you decide to house hack, then you will be forced to learn the basics of real estate. Not only will you need to navigate the home buying process, but also become a landlord to successfully house hack.
This offers the opportunity to get comfortable with real estate without putting too much capital on the line. You can take these skills and apply them to future real estate investments.
Type of Rentals You Can Do for Your Style of House Hacking
Finding the space to rent out is only the first piece of the puzzle. You also have several ways to rent out your extra space. Choose the option that best suits your lifestyle.
You can offer your extra space to short term renters through platforms like Airbnb, Homeaway or VRBO. Typically, these tenants pay by the night and you won’t have a longstanding relationship with them.
Short term rentals can give you more control over how frequently you have tenants. For example, if you want to reserve your guest bedroom for friends or family occasionally then you can choose to not rent out space for those dates.
The constant turnover can come with extra work but you might be able to minimize this burden by hiring out tasks like cleaning in between tenants.
A mid-term rental would be anywhere from one month to one year. Many people need mid-term housing options. A few include traveling nurses, students on a fellowship, or corporate housing for traveling businessmen.
The turnover for this type of arrangement would be less frequent, so there would likely be less work on your end. However, there would be a tenant in your space more often so there is a trade-off. In addition, a lot of folks that look for housing for a couple of months want it to be furnished.
A long term rental is for tenants that plan to stay for a year or more. The key for successful long term rentals is to successfully screen your tenants before entering a lease agreement. Make sure that your potential tenants can afford the rental. Also, if they will be sharing your space, then make sure that you can get along with their personality. Otherwise, it can make for a difficult situation down the road.
The Numbers of House Hacking
House hacking can be a quick way to change your financial situation for the better. However, not every deal is a good one. You’ll need to carefully run the numbers of a deal before pulling the trigger.
Here are the numbers you’ll need to evaluate to ensure you are getting a good deal:
The 1% Rule
The 1% rule is a great rule of thumb for real estate deals of all kinds, including house hacks. In order to abide by the 1% rule, a property should be able to bring in a gross monthly rent equal to 1% of the total investment on the property. You can also stretch this to the 2% rule in some cases.
So, if you buy a home for $100,000, then it should be able to bring in $1,000 per month in rent according to the 1% rule. This rule can help you weed out the less profitable properties in your search.
A final number to look at is your cash flow. Essentially, you subtract any expenses from your gross rental income. Of course, positive cash flow is a great sign. After all, it is a great feeling to get paid to live in your own home. However, even if you are only able to cut your housing costs in half, that is still a big win for your budget. Take a minute to decide what type of cash flow you want to achieve with your house hack before getting started.
Here’s how my cashflow looked on my second house hack:
Gross Rental Income: $1,200/month
Home Owners Association: $175/month
Mortgage, including taxes and insurance: $700/month
I bought the 4/4 condo for $92,000 and spent $2,000 for a few minor repairs upfront. Overall, my monthly cash flow was $145/month for the first year. After I moved out, the monthly cash flow bumped up to $437 because I was able to rent out the fourth bedroom.
Affordable Financing Options
One thing great advantage of house hacking is that you can take advantage of owner-occupant financing opportunities. Many lenders offer home buyer loans that are aimed to make buying a home more affordable. Most of these programs offer lower down payment requirements which can help you start your house hacking journey quickly.
Here are a few options to consider:
FHA. FHA loans are offered by the Federal Housing Administration. As of 2019, you’ll only need to put down 3.5% to secure this home loan. Plus, the lending requirements are less strict that most conventional lenders.
- VA loans are backed by the Veterans Administration to help veterans get into their own homes. Generally, it is an easy loan to qualify for and you will not have to put any money down.
USDA. If you live in a rural area, then USDA loans backed by the US Department of Agriculture are a great option. They require no money down which can be a game changer.
Conventional loans. Even conventional loans can be a good option for owner-occupants. Depending on the lender and your creditworthiness, you may only need to put down 3-5%.
How to House Hack
If you are ready to start house hacking, then take action! Here is what you’ll need to do.
Find the Property
The first thing you need to do is to find the right space.
If you are already a homeowner, then you might have an extra room available. Think outside the box. Instead of thinking about what might not work, think about what would. For example, could you convert the basement into a functional living space? Or would building an ADU be a better option for your situation? Don’t be afraid to think about unconventional approaches to house hacking!
If you aren’t a homeowner, then you’ll need to find a property before you can start house hacking. One advantage is that you can start your home search with tenants in mind. Find a space that would work for you and your future tenants.
Run the Numbers
Once you find a property you are interested in, run the numbers of the deal. Make sure that you are comfortable with the projected cash flow and cap rate before moving forward. Not every deal is a winner, so don’t be afraid to move on to another property if something doesn’t feel right.
Secure the Financing
After you are satisfied with the financial viability of a deal, then look for financing opportunities. As an owner-occupant, you should not have too much trouble securing a mortgage. If you are having difficulty, then you may need to work on your credit score.
Close on the Property
If everything goes according to plan, you’ll close on your house hacking property smoothly. It will be a great introduction to the world of real estate to prepare you for potential deals in the future. Once you have the keys, make any repairs to the property and spruce it up for new tenants.
Find the Right Tenants
As you start to fill your property with tenants, it is important to screen them appropriately. Although your methods will vary based on the length of your rental, make sure you are comfortable with the people moving onto your property. After all, you may be in relatively close quarters. You don’t want to have a tenant that is rude and incapable of paying their rent on time.
Maintain the Property
As time goes on, repairs will inevitably pop up. It is important to stay on top of the minor repairs as they come up to avoid any building problems. Also, keeping an emergency fund for unexpected expenses on hand can smooth over any cash flow hiccups that you might encounter.
Watch Your Savings Grow
If you’ve found a good property to house hack, then your housing costs should drop dramatically. With that, you’ll be able to redirect that income towards other financial goals such as saving or investing for your future.
The Bottom Line
House hacking is a great way to get started with real estate investing. Whether you try this tactic at 20 years old or later in life, it can accelerate your path to FI. Don’t wait to take action on this powerful financial strategy!