If there is one thing I really wish my younger self knew about, it’s house hacking. My life would probably be quite different if I had known then what I know now. So if you are thinking about buying your first home, or your next home, or want to buy a home but aren’t financially ready to yet, this post is for you.
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Contents and Quick Links
What is house hacking?
The term house hacking probably first came to existence thanks to Brandon Turner at BiggerPockets.com. He wrote a great book called The Book On Rental Property Investing, and co-hosts the Bigger Pockets (BP) Podcasts on real estate investing (REI). If you are interested in REI, I highly recommend checking them out. The term has gained further recognition through Scott Turner, also with BP, and his book titled Set For Life – Dominate Life, Money and The American Dream.
House hacking is when you buy a home and then rent out rooms or a portion of the home. This is the point, if you are anything like me, where you stop reading and tune me out. Because who wants roommates?!?
But wait! It gets interesting.
Let’s use an example of what I wish I had done when I was younger.
When I went to college, my parents gave me a $1,300 allowance for rent. This is what the average rent was in my college town.
Home prices averaged around $200,000 for a 3 bedroom/2 bathroom.
So long as you live in the home for 1-3 years, a down payment could be as low as 3%-3.5%. My parents would have to help me to purchase the home myself, since the owner must be an occupant to qualify for the low down payment.. Here’s what the purchase and mortgage would look like if my parents had known about house hacking:
Home price: $200,000
Down payment of 3.5%: $7,000
30-year FHA loan with interest rate of 5%
Private mortgage insurance: $158
Principal and Interest: $1,036
Total monthly mortgage: $1,194
When you are young and in college, having roommates is the norm. Let’s say my parents help me to rent out the two bedrooms for a steal of a price, $750/month.
Total monthly rents: $1,500
Instead of paying $1,300/month in rent to live by my college, we could have been collecting $306/month (rent – monthly mortgage payments).
In less than 4 ½ months, we would have recouped the down payment on the house, and once I finished college, the home would continue to bring in rental income.
Not convinced yet? Let’s look at another scenario.
You’re in your mid-20’s and working in a nice downtown area and saving for financial independence (because clearly you’re smart and have read this blog!). Since your career is off to a great start, you are finally making a solid income and thinking about your first home purchase. This is the point in your life where you can buy the nice home and the nice car and start your journey to keep up with the Joneses.
OR….. you look into that solid duplex you saw for sale just a couple miles from your work.
Purchase price: $300,000
Down payment of 3.5%: $10,500
30-year FHA loan with interest rate of 4.6%
Private mortgage insurance: $236
Principal and Interest: $1,490
Total monthly mortgage: $1,727
Since this is a duplex, you rent out one half and live in the other half. Since this is still a primary residence, you can take advantage of the low down payment. Market rent is $1,300/month. Your mortgage payments are now just $427. That’s a whole lot better than the mortgage you’d likely be paying for the larger home next to the Joneses that you could have bought instead.
What you save by house hacking:
The American Dream is alive and well. The usual steps look something like this:
- Go to the best university you can get into
- Land the career job
- Save for your first home
- Get promoted
- Buy a nice new car
- Buy your first home
- Get promoted
- Upgrade car and home
Going off of example #2, the home you would have purchased if you weren’t planning for financial independence would have likely been priced around $370,000. The mortgage would be around $2,200. By going with the duplex and living in one half and renting the other, you save over $1,700 every month.
Now let’s invest that $1,700 in a fairly conservative exchange traded fund (ETF) earning an average interest rate of 4%.
Similar to the calculations from The True Cost of Your Morning Latte, we can use these numbers in the compounding interest calculator found at the calculator site. Here’s the results:
After one year you have saved $20,800.
In five years you have saved $113,000.
In 10 years you have saved $251,000.
Or, in 5 years you could be ready for your family home and decide to use this $113,000 as a large down payment and then rent out the other half of the duplex. Now you collect $2,600 in rent, which will significantly help cover your new mortgage.
How does house hacking sound now?
House hacking is when you buy a home residence and utilize rental income to supplement mortgage payments.
By purchasing a larger home and renting out rooms, or buying a small multifamily (1-4 units) home and renting the other units out, you can either shave off all or most of your monthly mortgage payments, or even make a profit every month.
After 1-3 years of living in the home, depending on the terms of the loan, you can legally buy another property (as your primary residence and take advantage of the low down payment) and use the first home as a rental investment. These rents will continue to help in covering all or most of your next home mortgage.
Bonus: This process can be repeated every few years, depending on the loan program.
While I did not account for property taxes in my calculations, and I made many estimates and assumptions, the concept of house hacking is the same regardless of your area and market.
That being said, you must do your research and run the numbers for yourself.
With proper research and due diligence, deals can be found in any location and market, and house hacking can work for you. I fully plan to take advantage of this when my son goes to college.
There are two books that I recommend if you want to learn more about real estate investing. I will be reviewing them in the future but if you are feeling super eager and want a jump start, here they are:
The Book on Rental Property Investing: How to Create Wealth and Passive Income Through Intelligent Buy & Hold Real Estate Investing! by Brandon Turner with BiggerPockets.com. This is a good starter book on REI and covers all the basics you want to know before diving in.
The Book on Investing in Real Estate with No (and Low) Money Down: Real Life Strategies for Investing in Real Estate Using Other People’s Money. This is also by Brandon Turner and covers some more creative ways to get into REI.
Set for Life: Dominate Life, Money, and the American Dream. Written by Scott Trench with BiggerPockets.com and co-host of the BiggerPockets Money Podcast. Scott reviews how he was able to utilize house hacking and how it was pivotal to his path to financial independence.
Think about the following questions:
- Can you imagine how your life might be different if you owned a cash flowing rental property right out of college?
- As a parent, can you imagine making money each month rather than paying your child’s rent while they are in college?
- Can you think of way to utilize house hacking in your life?
- Following my examples above, do a little research on home prices in your area and average rental income. Run some rough numbers on either homes with >2 bedrooms or multi-unit properties. Be sure these are homes you would be comfortable living in yourself for the next 1-3 years.
- Calculate how much money you could be saving on mortgage/rent every month.
- Calculate how much money you would need to have for a 3.5% down payment on these homes.
- How much money could you save or borrow to meet this down payment?
- What would that extra savings mean to you?
Be sure to leave a comment below and let me know your thoughts on house hacking!
If this article was useful, please spread the word! I wish I had known about house hacking years ago, it would have changed my life.
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In the steps necessary to achieve early retirement, there will come a point where you are able to save enough money to start investing.