House hacking is a great strategy to introduce to clients who are interested in purchasing an investment property but may not have enough money to own a stand-alone rental property. Here’s what to know.
Low mortgage rates and high buyer demand has made both experienced and first-time investors hungry to jump into the real estate market. But a dwindling housing inventory has caused bidding wars and sharp increases in listing prices nationwide. For many, this has placed their dreams of property investment out of reach, but house hacking has the potential to overcome these financial hurdles.
The economy is only just beginning to recover from coronavirus shutdowns, and saving up for a large down payment and the associated costs of owning a property can seem far off.
Through house hacking, though, buyers with good credit can purchase property for as little as 3.5 percent down while minimizing their monthly mortgage payments and maintenance costs.
Here’s what agents need to know about house hacking, and what they should educate their investor clients on.
What exactly is house hacking?
House hacking involves purchasing a duplex, triplex or fourplex and living out of one of the units while renting out the others to tenants. The income generated from monthly rental payments is typically enough to cover nearly all or all of the owner’s monthly mortgage payments, drastically reducing the amount of money they need to spend on the property’s mortgage and other costs.
House hacking is good for investors who want to try out real estate investing without the full commitment of purchasing a rental property. Although it’s common for house hackers to start out with one or two properties, scaling up can be easy once a property’s cash flow is combined with W-2 income.
For clients looking to quickly scale up their house hacking operations, agents can suggest that they sell their current property and purchase multiple replacement properties with the profits, using a 1031 exchange to defer capital gains taxes.
How to house hack
If your clients are ready to start house hacking, use the following steps as a guide for their investment journey.
1. Find a property
Staying on top of MLS alerts and getting to a property before the competition is crucial, especially in the current seller’s market. Make sure to set up notifications for clients every time a house that matches their criteria hits the market.
Off-market properties are another good way to find potential house hacks, but this method requires a lot of time and persistence. Tap your contacts to see if they’d be willing to sell a property even if it’s unlisted.
Investors can use online tools such as Zillow’s Zestimate to get an idea of how much a property is worth. For homes on the market, the median margin of error is 1.9 percent, and for off-market homes, it’s 7.5 percent.
2. Choose the right financing
There are three main paths that investors typically take to finance a house hack. The first option is an FHA loan, which requires as little as 3.5 percent down. These loans are backed by the federal government, and therefore come with stringent rules.
Borrowers will have to pass an FHA inspection and prove that the property has no major defects (e.g., no peeling or lead paint, all core systems in good working order). These loans do not have high credit score limits (580 minimum).
Conventional mortgages are the next option. These loans require 10 percent to 25 percent down for a lifespan of 15 to 30 years but have higher minimum credit score limits than FHA loans (about 620 minimum).
If your client is a veteran, then they should definitely pursue a VA loan. These loans require 0 percent down, and the inspection process is less vigorous than an FHA loan.
Once your clients have purchased the property and acquired a loan, they always have the option to refinance later down the line for a better interest rate. They can also take out a personal loan for renovations with ARPs as low as 4.99 percent.
3. Take monthly expenses into account
To understand how much money a property can truly generate, make sure clients understand the expenses involved in owning a home.
In addition to monthly mortgage payments and closing costs, they will have to budget for property taxes, homeowners insurance, utilities, maintenance, apartment vacancies, capital expenditures and property management fees.
4. Live-in landlord
One important thing to make clear to your clients is that doing a house hack means they will be acting as a live-in landlord. Some investors may be weary of this fact and might think tenants will be constantly knocking on their door to make repairs or discuss the rent.
Offer them tips to manage tenant expectations, such as introducing themselves as the property manager instead of the landlord, including “rental rules and communications” in their lease, setting up online payments and performing background checks on all tenants.
House hacking is a great strategy to introduce to clients who are interested in purchasing an investment property but may not have enough money to own a stand-alone rental property. Just make sure they understand what is involved and the level of time and commitment it will take to make their investment successful.