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What is House Hacking?

Five years ago, a friend approached me with a radical idea: would I want to buy a house with him and a few others?

Pooling our resources, we could have a chance at a large home and we could cut our costs compared to renting. I thought it sounded crazy!

Looking back at it, I now realize what he was suggesting was a popular technique for jump-starting your wealth journey: house hacking.

While this example might have gone down in flames with multiple owners in a college town notorious for tenant turnover, house hacking in general is a great way to lower your housing costs while building equity.

There is nothing new under the sun - Ecclesiastes 1:9

The phrase “house hacking” might be new to you, but the principle has existed for many years. Having roommates, buying a duplex to live in one side and rent out the other, and so on.

Two events conspired to bring this concept mainstream for people with some hustle in their bones and a desire for financial independence.

First, the Great Recession caused real estate values to plummet to bargain levels, mortgage rates to drop to historically low levels, and unemployment to rise forcing people to search for additional ways to make money.

Second, becoming a landlord became accessible and cheap with new online resources like Craigslist, Cozy, Airbnb, and VRBO.

How do you get started?

New School

Buy a place with more space than you need and rent separate bedrooms. You will have to share common areas with your tenants, but if you’re young, this won’t be so different from living in a dorm. This model works with a long-term or short-term rent model (Airbnb hostels). Cons: Dealing with potential for awkward interpersonal conflicts (e.g. different standards of “clean”) and high turnover.

Old School

Buy a small multifamily (2-4 units), live in one of the units, and rent out the rest. Your tenants’ rent helps cover the mortgage and other costs, leaving you with a discounted housing price. While not as common with today’s increased housing costs, it was even possible to live for free and have a little extra cash flow to boot. Cons: Multifamily properties tend to be more expensive than single family houses. There’s a trade off between neighborhoods that cash flow and hip areas you might want to live long-term.  Ultimately it’s a personal decision.

How do you afford it?

Worried about affording a place to house hack? You can finance either approach.

A popular option is the FHA loan. Normal mortgages won’t cover small multifamily properties, but FHA will. FHA loans require as low as a 3.5% down payment for 1-4 unit properties and traditional loans can go as low as 5% down for a single family loan.

FHA mortgage rates are generally a bit higher than comparable conventional loans and also require mortgage insurance (PMI) for the life of the mortgage if the down payment is less than 20%. This contrasts to conventional loans, which terminate PMI payments once the loan to value (LTV) drops below 80%. FHA They also have lower credit score thresholds if yours isn’t as high as you’d like it.

If you’re set on buying a traditional multifamily property, there’s a great perk to the FHA program. Normally, a conventional loan has an upper price limit before crossing into what are called jumbo mortgages. This limit is set at $453,100 for 2018, but gets adjusted higher in more expensive areas. In Denver, that limit is $529,000. Topping the list are areas like Hawaii, San Francisco, and New York City at $679,650. If you’ve gone looking for a duplex, triplex, or fourplex in a popular area, you’ll know that almost all of these are priced higher than the single family limit. Conveniently, the FHA program scales the conforming loan limit UP as the number of units increase! Check out your county’s rate, set through HUD.

This means you could take $47,410 as a 3.5% down payment and buy a $1,354,585 fourplex! You won’t find financing terms like this anywhere else!

A caveat – triplex and fourplex properties do have to meet certain rental income percentages in order to qualify for the loan. In case the borrower defaults and the lender has to reclaim the property, this gives the lender some assurance that the property won’t be a massive loss.

Now you’ve seen that buying a place to house hack today could actually be attainable, even in this period of low supply and high demand, what’s holding you back?

While it’s easy to look back and think of missed opportunities to make money, including my friend’s idea five years ago, what matters is what you’re going to do today to achieve your goals.

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