The 5 Step Process to House Hacking Your Way to Financial Freedom: Part 1

Over the past several years, real estate investing has been a very hot topic. More and more people want to do it and there is a plethora of information out there to learn from. It has come to a point where there is too much information and people are getting analysis paralysis. My goal is to help with that and give you one strategy to focus on in your first year of real estate investing.

This strategy is none other than house hacking. This involves buying a 1-4-unit property and renting out the other units or bedrooms to offset the cost of your mortgage and other expenses. If done correctly, you can live for free and even make money to buy a property.

House hacking is one of the best ways to generate wealth in the beginning stages of financial independence and here is why:

  • It can either reduce or eliminate one of your largest monthly expenses – your living expense
  • Instead of wasting money on rent (making someone else money) you are paying down your mortgage every month, building equity. Not only that, if your market appreciates, you gain that equity as well
  • Finally, you are able to save on taxes. Since you own real estate, you are able to deduct a portion of your house expenses and a certain amount of appreciation.

Personally, I have done two house hacks thus far and I plan on continuing this up until I decide to have kids. I am going to share with you the steps you can take to accomplish this and the results possible, if done correctly.

The power of house hacking is significant – do yourself a favor, buckle in, and get ready for this two-part series of the 5 steps you can take to set yourself up for success.

Step 1: Prepare yourself Financially

Before you purchase a house, you need to build up some reserves and strengthen your financial position. It helps to have good credit when you are applying for loans and have a solid debt-to-income ratio. While there is lower credit score options, having a higher credit score will allow you to get better rates and can save you a lot of money in the long run.

When I purchased my first house hack property, I had around $20,000 saved up and a 750-credit score. The money I had saved up was going to be used for the down payment/closing costs and it left me enough for six months reserves, which the bank required.

This step in the process is vital. It is the catalyst in the next four steps and will allow you to be prepared when closing on your first property.

Step 2: Research your Target Market

After you have a solid foundation to purchase a home, your next step is to choose a market you want to invest in. This dependent on many factors such as work, family, military, and so on. The good news is house hacking works in pretty much every market across the US, even in places as expensive as the Bay Area of California.

This research stage is very critical because you want to make sure you are using the correct strategy, investing in the right neighborhoods, and using proper numbers when searching for the ideal house hack. A great resource to use when analyzing different cities and townships is to start with a city’s Comprehensive Annual Financial Report (CAFR). This is public information regarding the direction the city wants to move in. It includes data about employers, industries, population growth trends, job growth, economics, housing statistics, affordability rates, demographics, and so much more. Many people overlook this resource and it can be a great way to get an edge over your competition.

Another very important metric you want nail down when finding the right property for a house hack is, market rents in your area.

There are many online resources you can use such as Zillow, Realtor.com, Craigslist, and Facebook Market Place. From personal experience, I have found that in my market, Craigslist and Facebook Market Place have the most up to date information on properties for rent.

Once I find an average market rent on these sites, I go to a local property manager, one that I have built up a relationship with, and compare my findings to what he believes the market rent should be. After going through this process, I am pretty confident on what I can expect to rent out a property for.

The last thing you will want to do some research on in your particular market is what type of house hacking is the most viable in your area; and ultimately what type of house hacking you want to do. There are really three ways that you can house hack which include:

  1. The traditional house hack: This is where you purchase a 2-4-unit property, live in one unit, and rent out the other units. You can even live with a roommate in your unit and capture even more rent to cover your mortgage. This strategy typically works in lower-priced markets, such as the Midwest, where price to rent ratios are around 1%-2%. However, it does not usually work in more expensive market, where rents are not enough to cover the mortgage.
  2. The single-family house hack: This strategy involves purchasing a single-family home and then renting out the bedrooms or renting out the entire dwelling while still living on the land. If you don’t want to go extreme, you can live in one bedroom and rent out the remaining. Or you can go to extremes and rent out every single bedroom, while you set up a bed in one of the common areas of the house. You can even rent out your entire single-family house as one whole unit and then buy a camper to place on the property that you can live in. Single family house hacks work in nearly every market across the US, but they do pose more competition.  
  3. The ADU house hack: This strategy is a combination of the other two-house hacking strategies. An ADU is an additional dwelling unit and they can be smaller homes on the same plot of land as a larger, primary residence – Or they can we apart of the primary in a basement, in the attic, or a garage. Certain municipalities have different regulations regarding ADU’s, so if you choose this house hacking method make sure you check with local laws first. The great part about ADU’s is that are an entirely separate “unit” therefore you reap the benefits of a duplex, but they are still considered a single family.

If your municipality allows ADU’s you can purchase a single-family home that does not currently have one and make one yourself by converting a garage or building a small cottage in the backyard. Typically, this strategy works well in dense urban housing areas.

There are pros and cons to each house hacking strategy, however, it is up to you to choose the option that fits for you and works best in the area that you want to live in. You also need to choose your comfort level with each strategy.

To increase your income even more, you can choose to rent rooms and units through Airbnb. Just know these tend to take a little more work than normally renting out your property.

The strategy I chose was to buy a duplex and combine the strategy of renting out bedrooms in my unit as well. This allowed me to maximize my cashflow and actually make money while I lived there. I will go over the exact numbers and details in Part 2 of this post.

Step 3: Find a lender, discover your mortgage options, and get pre-qualified

The next step in your house hacking journey is to find a lender and get pre-qualified. This allows you to discover your lending options available to you. While there are many loan programs to choose from, I am going to only go over a handful of options that make a great way of getting started in house hacking.

  • The Conventional 97: This is a conventional loan that only requires 3% down. This loan requires you to buy a single unit home and you borrow no more than the national mortgage loan limit. Private mortgage insurance is required, but your down payment monies may be gifted by a family member.
  • The HomeReady Mortgage: This is another 3% down conventional mortgage. HomeReady loans are based on where you live and are available to people who earn less than the area’s median income, to home buyers within low-income census tracts, and to homeowners who are in federal disaster zones.
  • HomeStyleÒ Renovation Home Improvement Loan: This is a 5% down construction loan that allows you to fund the purchase and renovations of a property. Nearly every renovation or repair is allowed; the only requirements are the improvements have to be permanent fixtures and they must add value to the home.
  • Piggyback or 80-10-10 Loans: This loan is actually two loans put together. One mortgage is a lien for 80% of the home’s purchase price and the second mortgage is a lien for 10% of the home’s purchase price.

The total mortgaged amount is 90% of the home’s purchase price and the borrower is required to bring the remaining 10% as the down payment. PMI is not required on this type of loan because the first lien is for 80% of the home’s value. While Piggyback loans can be great, many mortgage lenders do not do them, so you’ll have to do some shopping around.

Besides conventional loans, there are also low-down payment, government backed loans. The difference is, conventional loans are typically easier and cheaper to get than government back ones. Some government backed loans include:

  • FHA Loans: An FHA loan is backed by the Federal Housing Administration and it only requires 3.5% down. These loans are designed for low-to-moderate income earners and require a credit score of only 580. In fact, if your credit score falls between 500-579, you can still qualify for an FHA loan if you put 10% down.
  • VA Loans: VA loans require 0% down on most home purchases, no PMI is required, there are no penalties for early repayment, and they provide free mortgage counseling for distressed borrowers. These loans are designed to help Veterans and other eligible borrowers to obtain mortgages.
  • USDA Home Loan: These loans are backed by the United States Department of Agriculture and they provide up to 100% financing. In order for a property to qualify for a USDA loan, it must be located in an area deemed eligible by the USDA’s Rural Development department. Click (here) for eligibility.

As you can see, there are many mortgage options when purchasing a property with a low-down payment. Shop around your area and find a bank or credit union that you trust and want to work with. Once you find that company, you can ask them about all the loan options discussed and others that might be city or state specific.

From there, you can then get pre-qualified for the type of mortgage program you ultimately choose. This step is usually pretty easy, and your lender will require you to provide certain financial information. While it is great to get pre-approved and it allows you to make offers much easier, it is not a guarantee that you will qualify for a loan when you go through underwriting.

While this step might seem like a huge hurtle, it is best to find that lender you want to work with and ask them all the questions you have. They will do their best to get you pre-qualified, find the best loan option for you, and they will know about local programs are available, such as down payment assistant programs and grant.

Don’t be shy to call multiple lenders, shop around, and work with the person you feel most comfortable with and trust.

At this point in the process, you are well underway to become a new homeowner and setting up the path to financial independence. Continue on to Part 2 of this two-posts series learn about how to find a property, run your numbers, and get it ready out.

The 5 Step Process to House Hacking Your Way to Financial Freedom: Part 2

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