Hacking A House

Unlike a lot of “life hacks” that don’t stand up to scrutiny, house hacking is real, legal, and can allow you to own property with very little out-of-pocket costs.

Even if you don’t have a high-paying job and a small fortune to cover a large down payment, a house hack can help you get started investing in real estate a lot sooner than you might think.

I stumbled into house hacking by accident — you can read about it in my book, Backstage Guide to Real Estate — and for a while, I thought I’d come up with a genius invention that no one else knew about. Turns out, I wasn’t alone and plenty of others younger than me were winning with the same approach.

I wish I’d known about house hacking in my twenties instead of discovering it at forty. But here we are, and perhaps this will be just the thing for you right now, so let’s dive into it.

What Is House Hacking?

A house hack is when you purchase a property of up to four units and live in one unit for at least a year while renting the others. The income you generate from renting the units helps to reduce (or eliminate) the money you need to take out of your pocket to pay the property’s mortgage and expenses.

In a four-unit property, you’d want each unit to rent for more than 25% of the mortgage plus the expenses of owning and maintaining the place. (That new boiler and that roof repair aren’t going to pay for themselves, after all.)

After the first year, you can move out and rent the unit you used to live in, at which point the property should be cash flow positive. The goal is for your rental income from the property to go beyond merely covering your expenses and to start generating a profit with little to no effort on your part — passive income.

You can then start a new cycle with a different property, again with the plan to live there for at least a year. The long-term goal could be to build several (potentially up to 10) profit centers from your property investments.

Low Barrier To Entry

A house hack lowers the barrier to entry because this strategy allows you to acquire property with less upfront capital. It doesn’t require a large down payment, which makes a house hack viable for younger investors or really anyone who wants to start a real estate investment portfolio without much liquidity.

In many cases, you are able to purchase a house with a down payment of as little as 3% of the value of the property.

Compare that with a traditional approach to buying a home with the typical 20% down payment and you’ll see why house hacking is a quicker way to get your foot on the ladder.

Favorable Mortgages

The best type of financing available today is for properties that range from single-family up to four units. You can get a 30-year, fully amortizing mortgage with a fixed interest rate.

A fully amortizing mortgage is one where the loan payment terms are calculated over the complete span of the mortgage. Without this, there may be a large balance due at the end of the loan, which is usually due in a much shorter time period of 3 to 10 years instead of 30.

To qualify for these more favorable mortgages, the property must be your primary residence. The lower down payment and interest rate, are the key to the hack. If you don’t have those two components, often the math doesn’t add up to make this a profitable venture.

House Hacking Limits

House hacking is a relatively easy route to getting on the property ladder quickly but there are some important considerations to be aware of before you leap in.

You must buy properties with only one to four units if you want to use the house hacking approach, as the financing structure on purchases of properties with five or more units is completely different and not advantageous for this purpose.

You will need private mortgage insurance (PMI) before you can secure a mortgage with less than a 20% down payment. This is special insurance required by most lenders that is different than a homeowner’s insurance policy.

You must live at the property for at least one year before you can move and rent out your former unit. The rules on this are strict, so it’s not smart to claim the property as your primary residence if you’re not really living there.

You can’t hack more than 10 properties because of the way the loans are set up. In short, beyond this point, the loans will be structured differently. They won’t be a fully amortizing, fixed-rate mortgage with that very low down payment – which is what allows you to hack the house to begin with.

These great mortgages are available to consumers because of Fannie Mae and Freddie Mac which are separate U.S. government-sponsored enterprises. Essentially, each exists to help lenders provide debt at favorable interest rates by reducing the lender’s risk by guaranteeing the loan.

The Fannie Mae and Freddie Mac guidelines limit you to 10 properties per person. Some banks will only lend to you for up to six or seven properties, but there are lenders that will go to the full 10.

Beyond The Limits

Unfortunately, your house hacking empire can’t grow beyond 10 properties because your financing options become the same as a commercial loan, with a higher down payment and less attractive interest rates. At that point, you’re not able to “hack” your properties anymore but it doesn’t mean you have to stop investing in real estate.

Once you’re ready to go beyond the limitations of house hacking, you can continue to enjoy the benefits of real estate investing through many other options, including real estate syndications. These investments can produce passive income while also reducing the taxes owed from your house hacking empire through the magic of depreciation.

Whether you go big or small, the bottom line is that house hacking represents a chance to live at a drastically lower cost compared with traditional home ownership. It’s a great way to start building wealth and passive income.

I think house hacking is particularly suited for those with a flexible lifestyle that allows them to move every few years and acquire new properties. If you play your cards right, after you’ve hacked a few houses, they could even generate enough passive income to cover your mortgage payments on a large single-family home that really is just for you and yours.

Join Me Backstage

Join the Picheny Investors Club for all my best insights about understanding whether house hacking is right for you, along with support to make passive real estate investments that suit your long-term needs.