Often, little splurges like $5 coffees and avocado toast get a bad rap within the personal finance community. And it’s true, cutting back on smaller purchases can certainly help you to save more and better manage your finances. But when we focus too much of our energy on the small stuff, we can neglect to think about how we can optimize the big ticket items in our budget.
Instead of focusing on clipping coupons to save 50 cents at the grocery store, ask yourself if there are any changes you can make to your life that will create sweeping progress throughout your finances.
The three largest categories of your budget are typically housing, transportation and food. And working to get your “big 3” right can put you in a position to not sweat the small stuff as much. That’s why we love house hacking!
What is House Hacking?
At its core, house hacking is real estate investing. Except instead of purchasing a home to rent entirely to someone else, you only rent out a portion of a primary residence and you live there too. There are many different types of house hacks, but the main goal is to have other people pay money each month towards your mortgage and living costs. It’s the most effective way to reduce what is typically your largest monthly expense: keeping a roof over your head.
Common house hacking scenarios:
- Renting out bedrooms within a single family residence
- Owning a duplex, living in one half and renting out the other
- Building an ADU in your yard to rent out
- Renting out all or part of your house for short term rental stays
House hacking is a great way to turn your primary residence into an investment. Even better, you’ll get additional cash flow each month, and set yourself up for financial success!
You should also know that house hacking is usually a temporary solution to help you grow wealth more quickly. Most folks don’t want to share their primary residence into their 50’s, 60’s, etc. so it usually caters to younger wealth builders. (That doesn’t mean older folks can’t house hack! In fact, there are some great scenarios where that works out nicely!)
Ps. if you’re not looking to live in the home, here’s a complete guide to buying a long term investment property only.
Why House Hacking is AWESOME!
You may have heard personal finance gurus say that your home is a terrible investment. Unfortunately that statement holds some water. Especially these days given the significant decline in housing affordability across much of the country. Now don’t get me wrong- for many folks it can make sense to buy a home. Often, the lifestyle perks can make it totally worth it. You get to own your place, enjoy increased privacy and freedom alongside the peace of mind knowing you have a home base.
Plus, you are building equity, which is basically a forced method of saving. The whole “bad investment” thing comes when you compare your total return on investment buying a home to other investment opportunities such as putting your money into the stock market. Here’s why that is…
Even though your home might appreciate a lot over time (ask your grandparents what they paid for a house back in the day), a lot of people forget to factor in the cost of insurance, property tax, and home maintenance, as well as realtor fees and closing costs! 🥴 Primary residences, as it turns out, are EXPENSIVE!
How House Hacking Makes Your Home A Better Investment:
But by renting out a portion of your home, it makes that purchase much better from a returns standpoint. This is because your tenants will contribute towards many of these costs with their rent dollars. Overall, you’ll have a higher ROI and growth rate for that house.
On the other hand, if you’re looking to purchase a rental property, it may be more difficult to qualify for, and you won’t be able to take advantage of tools like FHA loans! You’ll need to prepare for higher interest rates and also save up a larger down payment.
House hacking is like owning a primary residence + a rental property all at once. It allows you to, in the famous words of Hannah Montana, get the best of both worlds. You get to snag your home with a lower down payment, lower mortgage rates, proudly live in a place that you own and also have tenants pay monthly towards your bills.
Plus, if you’re a “first time” home buyer, you can usually take advantage of lower down payment options from the government. Borrowers can also get the best type of rates and loan terms for “first time” purchases, as long as the place is their primary residence.
We’ll get into some math later on how house hacking can boost your finances. But the main goal is to live for cheaper by using other people’s incoming rental money. And if you purchase a large enough home, you could even live for free. 4-plex for the win!
At its core, house hacking is a way to dip your toes into real estate investing with less risk involved and a much lower barrier to entry.
How to Start House Hacking
If you’re starting from scratch and want to start house hacking, buying your first house hack is a process that requires diligence, patience, and a bit of a learning curve. To help you get started, we’ve detailed the process from beginning to end. We’ve also compiled a list of tips to help you live your house hacking dreams!
Step 1: Start Saving for a Down Payment
The first step in house hacking is the same as purchasing your first home. You need to find a way to come up with that down payment money!
Ideally, you’ll qualify for an FHA, VA or Conventional Fixed Rate Loan. These government backed loans have lower down payment requirements for first time home buyers. This can make it easier for you to save up enough of a nest egg to purchase that home.
Just remember that if you save up a lower down payment amount, your monthly expenses will be a bit higher. This is because a) you’ll be borrowing more money, and b) you’ll likely have some form of PMI, or private mortgage insurance. This is usually required with lower down payments (think: anything under 20% down) which protects the lenders in case you stop making payments. However, the extra income that you plan to receive by house hacking can help to offset these additional costs.
That being said, if you can afford to put the 20% down, we always recommend doing so to avoid PMI. Plus, it will often help you to get the best terms and rates on your loan. Save as much as you can!
Lastly, don’t forget to factor in closing costs and any necessary renovations into your budget! So if you’re thinking of buying a house for about $300,000 and putting 10% down payment, don’t just save up $30k. Factor in some of the additional costs…
The average closing costs are 2 – 6% of the total loan amount. So if you’re looking at houses in the $300k range, you’ll likely want to save an additional $10 – $15,000. And if the house needs work before you even move in, make sure you’ve got those dollars handy too!
How can you save that much money?
For some folks, the idea of saving up an entire down payment can be really intimidating. Magically saving up $50k or $100k can feel out of reach. But I promise, if you get creative, prioritize your goals and stay patient, you can achieve it!
Start out by looking to maximize your income. Consider asking for a raise at work, or look to switch companies to snag a significant pay bump. If you’ve got a few extra hours each week you could even consider starting a side hustle.
Then, work on cutting your expenses. You could switch to a bare bones budget for a few months, or use these 7 ways to save money this week. Each and every dollar you save has the potential to bring you closer to your home hacking dreams.
Where to save your down payment funds?
It can take many years to save up a full downpayment, so you’ll want your money working for you and not just sitting in a plain old checking account.
We strongly recommend a high yield savings account for all of your cash. You’ll not only make some decent compound interest on your savings, it’ll put all that cash out of reach from your regular spending account. This way you won’t be tempted to dip back into those savings for other purchases.
We’ve written a few posts on how to switch banks and take advantage of High Yield Savings Accounts. We love CIT Bank and use them personally for our real estate savings and endeavors!
Step 2: Get Pre-Approved for a Loan
As you near that all-important savings goal, it’s time to figure out how much house you can really afford.
Even though you’ll be planning to rent out some of your home, you’ll want to qualify for a loan based on your personal income and financial situation. Lenders usually don’t care about your grand plans to house hack and rent out half your new place. They care about whether you personally are financially fit enough to pay back the loan on your own.
It’s a good thing to stay within reasonable limits when getting home loans, because that way any rental income you receive is just icing on the cake.
Keep in mind that it might take you a while to find a new tenant, and every now and then a renter may need to break a lease, leaving you on the line for the entire mortgage payment! Plus, you’ll be a homeowner now which means fixing anything that goes wrong with that home. That means that banking on that rental income as straight profit each and every month is unwise. You’ll need to ensure that you can afford the property on your own.
How much house can you afford?
So how do you figure out what your realistic price range is? You can start out by playing around with a simple affordability calculator, like this one. But a good rule of thumb to follow is that you don’t want to be spending more than 28% of your pre-tax monthly income on housing. Additionally you’ll want to spend no more than 36% of your income on your total debt obligations. If you live in a high cost of living area, you may need to stretch a little bit beyond this, but aim to stay within that sweet spot!
For example, let’s say your salary is $120,000 per year. That’s $10,000 each month before tax. You’ll want your total housing costs to stay around $2,800 per month. The house price you can afford will vary, depending on your downpayment and the current interest rates, that’s where the calculator really helps.
Once you’ve run the numbers yourself, meet with banks, brokers and lenders to see who will give you the best rates and terms for a mortgage. Be sure to get a pre-approval letter from whomever you decide to go with. You’ll need it to begin house shopping!
What if I don’t have enough?
2022 and 2023 have been crazy years for real estate. Interest rates are really high, home values are even higher, and inventory remains low. Because of these reasons, housing affordability is at its lowest rate since 1989.
If you’ve run the numbers and simply can’t afford a reasonably priced house based on your current income and savings, that’s OK! Neither can 90% of the population! Just keep saving, increasing your income, and improving your financial situation.
Waiting to buy a great house at the right price within your means is way better than buying a run down project you can’t fix that’s outside of your true financial comfort zone. It’s OK to wait if you can’t afford something now.
Step 3: Find a Good House Hacking Property
Next up, it’s time to go shopping! This is probably the most exciting, albeit time consuming, step. That’s because you get to browse a bunch of properties within your target area to find a property that will suit both your own personal needs and those of a potential tenant.
Picking a great location
If you want to start house hacking, you’ll need to find the perfect spot. Because you’re looking for a good house hacking property, you’ll want to make sure there’s a rental market in the location you’re buying. Check out the vacancy rates for the towns or neighborhoods you’re interested in. Be sure to research the average rent for your area to better understand what kinds of returns you can expect.
For example, purchasing a home near a university could mean that every summer you’re flush with student applications! Or if you only want to rent out your unit part time on a website like Airbnb, you could search in an area with a lot of seasonal tourism. Either way, start thinking about what kind of tenant you want to attract. It can be helpful to consider things from their point of view.
Duplexes, triplexes, and fourplexes are ideal for house hacking. However, not all neighborhoods are zoned for small multi-family dwellings and they’re typically not located in the fanciest neighborhoods. That being said, the houses themselves have established rental records you can request from sellers. These numbers are incredibly handy when shopping for a house hack.
Remember, you’ll want to choose an area that YOU are comfortable living in – at least for a few years. It’s definitely important to keep tenants in mind, but make sure it’s convenient enough for you (and your partner/family) too.
What to look for in a house:
Plenty of good rental properties share similar qualities that you can look out for as you search!
The best thing about duplex, triplex or fourplexes is you can still qualify for FHA loans. Once a property has more than 4 units, you will no longer qualify for a traditional residential loan!
Alternatively, you can look for a property that has, or on which you can build an ADU (accessory dwelling unit). Think of it like a detached, standalone apartment on your property! This can provide both you and your tenant with additional privacy. There are various rules for building additional living spaces on a property, so familiarize yourself with local building codes first – don’t just assume it’s legal and start building!
If you’re super comfortable sharing your living space, you could just purchase a regular single family home. Renting out single rooms within your home is very common and you might even have some family or friends that would love to live with you! Just remember that you’ll have to find renters who are comfortable sharing the space as well.
Fixer-uppers can be a great way to get more for your money if you’re willing to put in a little elbow grease. If you’re planning on doing renovations anyway, it’s easier to build in separate living spaces or access points designated for roommates. Plus, you can make renovations based on what’s likely to attract great tenants.
Remember situations can change…
If there’s one thing we’ve all learned from the new Airbnb regulations in New York City, it’s that rules and regulations can change at the drop of a hat. While that doesn’t mean that you should let your dreams of running a short term rental slip away, it does mean that you should try to ensure your rental unit could double as a long-term rental should things change.
If the property you are buying only works if you are able to rent it via the short-term sites, you might be in for a rude awakening if local laws change, impacting your ability to rent in that manner. Make sure that your real estate dreams and recurring revenue aren’t dependant on a single platform.
Meet with Agents
While you don’t necessarily need to work with a real estate agent when searching for a home, choosing to partner with a trusted agent can greatly improve your home buying search. They have much more experience than you and are better connected.
A good realtor can save you both money and valuable time during your search. Often, they hear about home listings before they are available to the public, often known as pocket listings, giving you the chance to pounce first if you find something you like. They should know your target area like the back of their hand, and understand shifting trends within surrounding neighborhoods.
In addition to showing you listings, realtors will give you advice on bidding amounts, prepare your offers, obtain home records, manage inspections, and can help you to come up with a negotiation strategy.
Submitting Offers
Once you find a home that fits the bill, it’s time to submit an offer. Remember to be patient- you may not get the first few homes you submit an offer on. Don’t get discouraged! Just continue to search for places that fit your criteria and make offers until a seller accepts it.
Pro tip: Most offers you submit come with contingencies. For example, you may have the right to cancel the contract and back out within seven days if you notice big issues after you do a thorough inspection. Or you may have the right to terminate the contract for any reason at all within a three day time period. Each state and contract has its own specifics, so let your realtor help you in this process.
If you get into a heavy bidding situation, it’s really important not to forget your original finance criteria and stretch yourself too far. Emotions run hot during bidding wars, which can cause some buyers to waive inspections, or overpay for a property. Be aware of this and keep your cool! Houses are like buses… If you miss one, there’s another right around the corner if you just relax and wait.
Step 4: Close on Your House & Move In
Congratulations, you’re officially a homeowner! Crack open a beer, do a little happy dance, then go to sleep. Because tomorrow, the real work begins…
Once you close on a house hacking property, it’s a race against the clock to start generating some monthly rent. Because you’ll be paying the mortgage on your own until you get a renter, you’ll want to take care of any necessary renovations ASAP!
When it comes to renovations, make sure not to cut corners. You can either pay to do things the right way the first time around, or pay to do things both the cheap way and then the right way when your shortcut inevitably fails. We suggest doing it right the first time.
And make sure not to mess around with breaking the law. For example, if you buy a house in an area that doesn’t allow short term rentals, don’t do it! It’s not worth the stress.
Get ready to share your house:
Once you’re ready to start house hacking, you’ll need to be prepared to actually begin sharing your house. It can be a good idea to look into landlord insurance. This can cover things like property damage and liability in case someone gets hurt in your rental.
You can also make some minor adjustments to the space to make it more rental friendly. Most renters prefer a space that feels more private. If you can, make sure their room or unit has a private attached bathroom, or a kitchenette. You’ll likely be able to charge more and keep your tenants for longer.
You could even rent out extra parking space or garage space to your renter to make a little extra money!
Step 5: Pick Your Tenants and Start Cashing Checks
Now, it’s time to find tenants and start making that supplementary income baby!
Picking the best tenants certainly involves a degree of skill and hard work. If you have friends, family or someone in your network who is looking for a place to stay who you know personally, this could be a great place to start.
Someone who knows you and who you already get along with is much more likely to respect your space and make an effort to pay on time. Although you might be tempted to charge them less, this small dip in income could be worth the peace of mind knowing that your space is well looked after!
If you don’t know anyone personally, you can list your rental on websites like Zillow, Apartments.com, or even Craigslist. Once you get a few leads, be sure to do your due diligence and properly screen your tenants. Perform a background check, and ensure that they have solid income and earn approximately 3x the rent each month. It’s wise to call their former landlord to gauge their history as a tenant too!
You should also require your renter to get rental insurance. This can save both you and the tenant a ton of headaches. Rental insurance is often cheap and covers a tenant’s belongings in case of damage from things like theft and natural disasters.
Where to put your rental income?
OK, so you’ve just received your first rent check… Ca-ching! But what should you do with this additional income?
To begin with, use the rent checks to pay towards your mortgage, especially if you are paying PMI. Just because you’re making a little extra money does not mean that you should blow it all on splurges. You can use this extra income to make additional mortgage payments and pay off your mortgage early, or you can set some months aside to create a cash reserve in case you go a month or two in between tenants.
It’s always a good idea to create a sinking fund for unexpected repairs or disasters. Just like your personal emergency fund, you should build up around ~3 months of expenses and keep them in a high yield savings account.
Step 6: Plan Your Exit Strategy
One of the best parts of house hacking is that you can rinse and repeat it to grow a rental portfolio. After you live in your house for a certain amount of time (at least the minimum for your mortgage requirement), you can repeat the process of purchasing another home to be your primary residence and rent out a portion of that house.
You can use the knowledge you’ve gained from your last move to do it even better this time. Maybe now you can afford a bigger place or a larger renovation this time around. Either way, you can build on what you’ve learned and have an easier time the second go around.
When the time comes, you can convert your existing place to a full time rental property. Just find a tenant to take over your portion of the house! This then frees you up to move into your next house hack! Or, once you feel like you’ve saved enough, you could eventually convert it back into a primary residence for yourself.
Joel actually did this! After four years of renting out his duplex, he converted it into a single family home, using a lot of the profit he made over those previous years to make it happen!
Refinancing is another option
Depending on how much equity you’ve got (and the current interest rate environment), you may be able to refinance your mortgage and restart your loan term. There can be huge benefits to doing this.
First, depending on the interest rate and term, you might be able to lower your monthly payments. This equates to higher cashflow for you each month!
Another option is to do a cash-out refinance. This would give you a big chunk of money to start another real estate investing project.
In any case, you never want to ditch a great mortgage rate for a worse one. So, you’ll need to crunch the numbers yourself to see whether or not this is a good move for you and your personal situation.
House hacking example (with all the math!)
To better understand the house hacking process, here’s an example we’ve cooked up with all the math done for you!
Mike buys a house with a rundown ADU
Our friend Mike wants to start house hacking, and winds up purchasing a home with a run down ADU unit. He buys his home for $300,000, and puts down a 20% down payment of $60,000 to avoid PMI.
He also pays 3% of his loan amount ($240,000) in closing costs amounting to $7,200, and plans to spend about $50,000 on renovating the ADU.
Each month, his mortgage payment will cost $1,724. He’ll pay $198 towards property taxes, $66 in insurance, and because it’s suggested to set aside 1% of a home’s value for maintenance each year, he plans to put $3,000 into a sinking fund for maintenance/cash reserves.
So to summarize, Mike needs:
- $117,200 up front for renovations, a down payment and closing costs.
- Income to fully support about $2,243 each month to cover the mortgage, insurance, property tax, and to prepare for any maintenance costs for the home.
Next, Mike finds 2 roomates
After renovations, Mike gets 2 roommates! He rents out a spare bedroom in his home to one of his friends for $1,200 each month and shares a lot of the living spaces with him, like the kitchen and living room.
He also rents out his one bedroom ADU for $2,000 each month to a tenant.
Now, Mike is generating $3,200 in rental income! This not only fully covers his monthly expenses of $2,243, but he also makes an additional $957. On top of getting paid to live, he is also building equity!
On to the next property…
Five years later, Mike decides to move to a new house hack, and converts this place to a full time rental. He rents out his bedroom in the home for $1,200 each month. Now, he’s raking in a total of $2,157 each month from rental income..
Mike moves on to house hack #2 and repeats the process a few more times until he owns four rental properties in total and makes ~$8,000 per month in cash flow.
Other Ways You Can House Hack
Even if you’re a while away from that big down payment for your first house hack, there are still plenty of ways you can start lowering your housing costs right now! Here are just a few ways you can get started house hacking right now.
Work for Cheaper Rent
If you have a few extra hours each week, see if you can work out a deal with your landlord to take on a little extra responsibility in exchange for cheaper rent. For example, if you mow the lawn, handle some of the landscaping or gardening, or even offer to help them with some of the administrative work that comes with real estate investing.
While this likely won’t fly with huge real estate companies, providing value to mom and pop landlords can often help them to save time. And it can help you save money!
Get an extra roommate
Okay, so if you’re married with kids this hack might not be best for you. But if you’re young and maybe just starting out your career, see if you can get an extra roomie and share your bedroom with them. It’s not necessarily easy, but it can help you massively lower your housing costs.
For example, if you and your friends are planning on renting out a house with 4 bedrooms, with a rent of $4,000 per month, see if you can find an extra friend to share your room with. This would slash your $1000 share of the rent to just $500. Cutting your living expenses this low is a great way to start stashing away bigger chunks of money while you’re young so that you can enjoy the magic of compound interest for even longer.
Rent Out Garage/Workspace
If you don’t have an extra bedroom to rent out, maybe you have a garage spot you never use. Or, maybe a home office that you could rent out for cheap to make some extra cash! Even Matt and Joel rent out their podcasting studio from a friend. They get a great space to record, and their friend enjoys a little extra cash. Win-win!
Rent Space During A Big Event
Does your city have any big events that pull in tons of tourists? Consider renting out spare rooms in your home just for a week or two during these events to test it out. This can be a great way to earn some extra cash quickly, and get you closer to your personal finance goals.
For example, in College Station, TX people fly in from all over the country to attend Texas A&M football games. If you have a house close to the stadium, you may be able to rent it out for as much as $1,000 for the weekend! On those weekends when you rent out your place, you could travel cheaply for a few days, spending $500 and pocketing the other $500.
Pro tip: If you rent out your space for less than two weeks a year, you don’t owe any tax on that income thank to section 280 A(g) of the US tax code. Pretty sweet, right!?
Tips for House Hacking Success:
Even though the concept of house hacking may be simple, it’s not always easy! Here are a few tips to make house hacking work best for YOU!
Be Realistic
House hacking isn’t for everyone, and that’s okay! It’s going to be more difficult (but not impossible) for people in certain situations. For example, if you have young kids or are someone who values privacy above all. Since you are sharing your home with someone, it really can affect your mindset and quality of life.
That being said, it can’t hurt to give it a try! That’s why it’s so important to make sure you can afford the home on your own without a tenant. House hacking isn’t meant to be a long term solution. You can use it as a way to break into real estate investing and to create more margin in your life temporarily. A little pain now can result in lots of financial gain!
ALWAYS Screen Tenants
Even though you may not feel like it, you’re a landlord when you house hack! So always think like a landlord and find people who will treat you and your house with respect.
Make sure to be thorough in your screening, and don’t rush to put someone in your unit just to have them there. It’s better to have a month of vacancy than the headaches that a bad tenant can cause.
We discussed all about the easiest ways to screen tenants on Episode 44 of the podcast. Check it out! We walk through the stages of screening, and recommend resources we’ve used in the past to screen tenants effectively.
Always Sign A Lease
Even if your best friend in the world is moving into your apartment, it’s important that you always sign a state-specific lease with every tenant.
Think about it this way- signing a lease is a way of protecting your relationship with the tenant. Outlining the expectations of both parties right at the beginning can help you to avoid conflict in the future, because everything gets put out into the open at the start.
Pick the best type of setup for your life
In an interview with Craig Curelop, we discovered that he started out house hacking by renting out one unit in his duplex. And then he went even further by renting out his own bedroom and slept in the living room! He even went as far as to create a partition in the living room with a curtain for added privacy. While he certainly saved a lot of money, that kind of roughing it is definitely not for everyone.
Make sure to set yourself up for success by picking the best type of house hack for your lifestyle. If you’re the kind of person who covets privacy, you probably should find a duplex, triplex, or fourplex that ensures you’ll have a degree of separation from your tenants.
Pick the right neighborhood
This should be a given considering you’ll be living in this home too. Tenants don’t want to live in a dump, and neither do you! Picking a bad location can make it more difficult to find good tenants and can cut into the levels of appreciation your property experiences over time.
Utilize your extra income
Just because you’re making an extra $500 a month by renting out a bedroom doesn’t mean you should blow it all on fancy cars and watches! Often, we don’t even notice the richest people among us because they’re practicing stealth wealth.
The whole point of house hacking is to get ahead financially, not to live larger. So put all that extra money to good use. Use it to pay off your mortgage more quickly, save up a new down payment for another property, or to accelerate your path towards financial independence!
The Bottom Line:
House hacking can be a great way to get yourself ahead financially, all while dipping your feet into the real estate investing game. It can lower your living costs, generate extra cash flow each month, and help you build faster equity in your primary residence!
As good as this all sounds, house hacking requires a lot of hustle, and isn’t for everyone. You definitely don’t want to cut any corners or stretch yourself financially. Make sure you choose a house hacking strategy that fits in with your lifestyle. It will be more sustainable.
House hacking may feel at times like a sacrifice, but the financial advantage you will gain can be totally worth it! Good luck. Go get it!
Related resources:
- Chad “Coach” Carson is an awesome guy to follow and learn from. He’s completed many house hacks and shares stories on his podcast!
- The House Hacking Strategy is a great book by the Bigger Pockets team
- Using Credit Card Rewards to Travel for Cheap
- A step by step guide to moving out of your parents house
