“HouseHacking” is a hack that can be used to get into a home, even in the super-ludicrous speed Bay Area.
Househacking is purchasing a 2-4 unit building as your first home. You live in one unit, and rent out the others, allowing you to pay less mortgage each month. Here are three main advantages of HouseHacking:
1) You get to purchase an investment property, while taking advantage of the lower interest rates and lower down payment requirements enjoyed by homeowners,
2) you get additional purchasing power, and
3) you hedge risk by having rental income pay the mortgage.
This first installment here will cover best practices, so that you keep as much of your cash in your pocket as possible upon purchase, and you minimize monthly expenditures. Numbers, when used, will be stylized to illustrate the concepts with more detail to come.
- HouseHackers Pay Lower Interest Rates & Smaller Down Payments
Lenders charge higher interest rates on investment property than owner-occupied property. By purchasing a 2-4 unit building and owner-occuping one of the units for a period, you are classified as an owner-occupant and are given the lower interest rate.
You can also pay as little as 3.5% down for a 2-4 unit building using a Federal Housing Administration (FHA) loan. FHA loans are mortgages insured by the Federal Housing Administration. There are certain additional requirements of FHA loans and we’ll cover those later.
- HouseHackers Get Additional Purchasing Power
Lenders calculate the loan you qualify for based on debt to income ratio (DTI), the ratio of your monthly income to your monthly debts. In this example, the DTI is 43%, which is common. Let’s say your monthly income is $5,000, and you have no other recurring monthly debts. A lender can give you a mortgage for the loan amount that will result in a monthly payment of $5,000 * 43% = $2,150.
Now, let’s say that you purchase a property with three units (Triplex) and you plan to make one unit your home. This brings up the crux of the househack: 75% of the income from the two units that you don’t live in can be added to your monthly income of $5000. Let’s say each unit earns $1,500. From the lenders perspective, your income has magically jumped from $5,000 a month to (2*$1,500*75% = $2,250 + $5,000 = $7,250). Although before you could borrow up to a loan amount resulting in a $2,150 payment, now you can borrow a loan amount that results in a monthly payment of $7,250 * 43% = $3,117.50. The table below illustrates the impacts to your loan amounts from a duplex, triplex and fourplex (assumptions at end):
| Your monthly salary | Number of units | What lenders will loan based on your salary | The rental income lenders can use | Income from salary and rent together | What lender will loan you* | |
|---|---|---|---|---|---|---|
| *This is not the purchase price; It’s the purchase price minus your down payment | ||||||
| Single Family | $5000 | 1 | $2150 | 0 | $2150 | $424,326 |
| Duplex | $5000 | 2 | $2150 | $1125 | $3275 | $646,358 |
| Triplex | $5000 | 3 | $2150 | $2250 | $4400 | $868,389 |
| Fourplex | $5000 | 4 | $2150 | $3375 | $5525 | $1,090,420 |
Yes, the market is red hot right now. Will it be this hot in 2-3 years? Most would say probably not. According to the third-quarter 2017 Zillow Home Price Expectations Survey released in August, there’s a 52 percent chance the next recession will start by the end of 2019. If you feel like waiting for a better time to buy, I applaud your patience; it’s an understated virtue in this culture! If you are buying now, then HouseHacking is the most economically sound way of doing it. Why?
- HouseHackers Use Rental Income as a Hedge Against Risk
The rental income provides a hedge against risk. If you were to simply purchase a single family home now, and the value were to decrease, then you would be underwater, paying a mortgage on a price that evaporated into thin air. The housing market, and rental market are certainly linked but not the same. Were you to purchase a multi-family, then both the housing market, and the rental market would have to completely tank before your experiment in HouseHacking would be jeopardized. This prospect is not unthinkable, but it certainly would take something deeper than just the next down cycle.
Final Thoughts
HouseHacking makes the most sense when the option you are evaluating against is renting. So for example, HouseHacking makes economic sense when you can get into a scenario where your bottom line HouseHacking is lower than your bottom line renting (assuming you have the cash for a down payment). And, although becoming a landlord and property owner may not be suitable for everyone, there is much to gain for those that are willing to try.
Numerical Example Assumptions:
Interest Rate 4.50%
Debt to Income Ratio 43%
Loan Term 30 years
Rent per Unit $1,500