What is House Hacking and Should You Try It?

What Is House Hacking?

House hacking is a real estate investing strategy that involves buying a property, living in one part of it, and renting out the spaces you don’t occupy. It’s a simple strategy but remarkably powerful, and while the term “house hacking” has only become popular in recent years, the concept has been around forever.

House hacking is the perfect gateway into real estate investing. Most people instinctively recognize that buying property has tremendous potential, but it’s also intimidating. The high price tag and the complexity of managing a property scare a lot of people off, but house hacking offers a way to mitigate both of those issues:

• Living in the property makes it easier to keep up with maintenance, collect rent, and deal with problems as they arise.
• When you buy a property as your personal residence, some loans allow you to put as little as 3.5% down as a deposit (they’re called owner-occupant loans and have lower rates, too).

House hacking is also incredibly flexible, and you can make it work with almost any type of property. As long as you can fit more than one person into a space, it can probably work as a house hack. I’ve met people who have bought three-bedroom homes, cordoned off a section of the living room for themselves with a wooden partition, and rented out all three bedrooms.

Of course, that’s an extreme approach, and you don’t have to do that to be profitable, but it goes to show how creative you can get. Let’s take a look at some of the more typical arrangements that people use.

House Hacking With a Small Multi-Family Property

A multi-family property is any property that has multiple, separate units on a single lot. For the purposes of house hacking, that means duplexes, triplexes, and quadplexes. If you want to qualify for owner-occupant loans, your property has to be “residential.” That means it can’t have more than four units.

Multi-family properties are usually the standard for house hacking. It’s tough to say whether it’s more profitable to house hack with a multi-family home than a single-family home, but it’s almost always more comfortable. Rare is the person who likes sharing their bathroom with a strange man who always forgets to clean his beard hairs out of the sink.

Unfortunately, these properties are usually harder to come by than single-family homes. There are fewer of them, and there’s often competition from investors. Those factors can drive prices upward.

House Hacking With a Single Family Home

For those who are unable to afford (or find) a multi-family property, single-family homes can be a viable replacement. These are the properties that most people think of as a house. There are a lot more of them on the market in just about every city, so your chances of finding one that’s worth investing in are a lot higher.

There are obvious downsides to this approach. Again, whether or not it will be profitable depends on the location, the property, and the market, but it will always require that you give up some of your personal space. If you don’t mind sharing your sink with Johnny Beardhairs, though, it can be just as effective as house hacking a multi-family property.

If you’re planning to use a single-family property for a house hack, you’ll need to assess the property carefully. Consider ways to divide the property or convert a portion of it to a separate unit. Consider your own comfort and that of your tenants. A well-planned and well-executed division of the unit will have more value and attract a better class of tenant.

📘 Want to learn about some of our other favorite real estate investing strategies? Take a look at our introduction to the asset class: Investing 101: Real Estate Investing For Beginners

House Hacking With Long-term vs. Short-term Tenants

Long-term tenants are what you probably imagine when you think of renters. They usually sign a lease for somewhere between a month and a year. Short-term tenants may only stick around for somewhere between a night and a week (think Airbnb and VRBO).

There are pros and cons to both:

• Long-term: Keeping tenants in your property for months or years at a time is ideal for those who prefer stability. You wouldn’t have to worry as much about generating demand or turning over your property. Your rental income will be predictable. That said, when a tenant does leave, there will usually be much more extensive repairs necessary before it’s ready for the next one, and they’re noticeably less profitable.
• Short-term: Bringing in tenants on a daily or weekly basis is a lot more work than a long-term rental. You’d have to clean the place between each one and worry about a lot more people. Your income may be seasonal or unpredictable. On the bright side, you can charge a lot more for a property on a nightly basis than you can on a monthly one.

In short, you’d want to choose long-term tenants if you want as passive an experience as possible. If your main priority is making as much money as you can, short-term tenants are usually the better way to go. Be sure to consider your available time and your housekeeping skills before deciding on short-term rentals. You’ll also want to consider whether your location attracts a year-round stream of short-term visitors.

The Advantages of House Hacking

I said that house hacking is one of the most powerful strategies for building wealth because it can get someone to pay for your housing. Of course, that’s an oversimplification. Let’s take a look at exactly why it’s so useful. It’s going to be a long list, so bear with me.

A successful house hack allows you to:

• Generate Passive Cash Flow: If your rental income for the property exceeds the cost of owning it, your home will actually put money back into your pocket every month instead of taking some out. Even if you don’t have positive cash flow while you live in the property (those owner-occupancy loans require that you do so for a year), it should if you ever decide to move out. Even if you only manage to break even, that still means you’re living for free!
• Maximize Leverage: Leverage (debt) is a big part of what makes house hacking so powerful. You only have to pay a fraction of the price of a property to gain access to it and benefit from its cash flow and appreciation. Mortgages are also among the lowest-interest loans you can get. That lets you pay for a valuable investment with a low-interest loan, and that’s unusual: good luck getting a lender to give you a mortgage to go buy a bunch of stocks!
• Build Equity: Have you ever heard someone say that renting is like throwing money away? That’s because owning a property allows you to build equity that you can tap into later. You can potentially recoup all the money you put toward the principal balance of the property when you sell it. If you select quality properties in good locations their value is likely to increase.
• Diversify Your Portfolio: One of the keys to successful investing is diversification. If your portfolio is entirely comprised of paper assets like stocks and bonds, having a rental property or two is a great way to hedge your bets against market downturns and inflation. 
• Receive Tax Incentives: The tax code has dozens of rules that incentivize real estate investing. You can take deductions for maintenance, depreciation, property taxes, mortgage interest, and more. If you decide to sell your property, the IRS will tax the capital gains at rates far lower than ordinary income rates. If you live in the property for two years, you can even exclude $250,000 of those gains.

Honestly, the list above probably isn’t exhaustive, but it should get the point across. House hacking can turn the most common obstacle to saving money (having to spend thousands of dollars a year on shelter) into a wealth-generation machine.

Let’s take a look at a couple of examples that demonstrate the power of house hacking.

House Hacking in Action

Take a look at the numbers above. They’re just approximations, but they’re realistic ones. Both would be solid deals, but not extraordinary.

👉 Let’s walk through the first one. Finding a triplex in a mid to low-cost-of-living city for $250,000 might be tough, but it’s doable. If you rent each unit for $850 a month, put 5% down, and reserve 1% of the value of the home each year for miscellaneous costs, you’d have to pay just over $100 a month for your own housing. After moving out, you could get another $850 a month, bumping your cash flow up to $736 a month.

👉 Next, the second example. Buying a single-family home in a mid to high-cost-of-living area for $500,000 is achievable. You’d get more rent for each bedroom due to the location, but the extra debt would outweigh the benefits by a bit. Still, you’d only pay $660 a month for housing live in a location where homes are worth half a million dollars. Once you moved out, you’d be up almost $500 a month in cash flow.

Now, consider how much better off the owner of each of these properties would be than their tenants. The owner of the first property would pay $736 less than their tenants to live in the same place. How much better off would you be if you could save $700 more a month? That would compound into more than $120,000 of additional wealth if you lived in the property for just a decade. What if you did a second house hack the next year? What if you kept going?

🧮 Want to see how much wealth your house hack could generate? Use this calculator to see the effects of saving extra money each month: Savings Calculator

The Disadvantages of House Hacking

A good house hack is one of the best investments that you can make. It can revolutionize your life and put you on the fast track to financial independence. That doesn’t mean it’s all puppies and rainbows. There are risks involved and obstacles to overcome. Like any worthwhile goal, house hacking takes some hard work.

So before you go rushing off to throw money at a random real estate agent, let’s take a pause. Investing can always go wrong, and house hacking is no exception. It presents four major challenges. They are:

• Saving the Cash: Real estate is a capital-intensive investing strategy. There are costs to get into the property upfront (downpayment, closing costs), and costs to own it each month (mortgage, taxes, and maintenance). Don’t try to jump into real estate without a strong financial foundation.
• Getting a Loan: Having the money for a down payment doesn’t guarantee that you’ll qualify for a mortgage. These days, you’ll need to have at least a good credit score, a stable income, and the patience to work through the property purchase process.
• Finding the Deal: Compared to investing in something like passive index funds, real estate takes a lot of research. Good deals usually don’t just fall into your lap. You’ll need to learn to analyze properties, get over the fear of making offers, and likely look at many properties you don’t want and deal with more than a few rejections before you can close on a property.
• Dealing with Tenants: Once you have your property, you need to get some into it, collect rent from them each month, keep them from destroying it, and fix the things they break. Some house hacks also put you in direct contact with your tenants. It might not be so bad if you live in separate units, but sharing a living room might not be fun.

House hacking is a powerful strategy, but it’s not foolproof. There are risks and limitations, as there are with every investing tactic. It will take more effort, thought, and energy to pull off than sticking your cash in an index fund, even if you get a property manager and only rent out your garage.

Don’t underestimate the challenges of real estate investing. It’s not a get-rich-quick scheme, and anyone who tells you otherwise is selling you something you probably don’t want.

📘 Are you hunting for new ways to reach financial independence and retire early? Take a look at our suggestions: How to Retire Early: The Shockingly Simple Path to Freedom

Should You House Hack? Ask the Experts

House hacking has the potential to be a life-changing investment. It’s one of the best ways to rapidly scale your net worth, develop a passive income stream, and reach financial independence. That said, it’s not the right move for everyone. Tying up your cash and taking on a mortgage can be daunting, and there are significant personal considerations.

If you’re unsure whether house hacking makes sense in your situation, don’t hesitate to talk to an expert (or ten). There are plenty of local real estate meet-ups across the country, and you can find plenty of more experienced real estate investors there. You should also reach out to lenders, real estate agents, and a Certified Public Accountant to make sure that your investments make sense before you commit.