Have Renters Pay The Mortgage By ‘House Hacking’ Your First Home

Dan rafter
Written by
Dan Rafter
Read Time: 7 minutes

Don't have enough money to buy your first home? Or want to build equity quickly? One option for entering the housing market is to “house hack” and buy a multi-unit home to rent out to tenants and charge them enough to cover the mortgage, or close to it.

As a first-time homebuyer you could be a landlord in your own home, but with renters in separate units instead of sharing the kitchen, living room and other common areas.

Conforming loans and home loans insured by the Federal Housing Administration, or FHA, have higher loan limits on up to four-unit homes, provided the buyer lives in one of the units as their primary residence. This can allow buyers to own a higher-priced home than they would otherwise, since 85 percent of the overall rental income can be added by lenders to a buyer’s personal income to qualify for an FHA loan, and up to 75 percent by conventional lenders.

Along with paying a mortgage, income from renters can be enough to pay for home insurance, property taxes, maintenance and other costs of owning a home.

FHA loan limits vary by county. The standard FHA loan limit for a two-unit home is $538,650, about $118,000 more than it allows for a one-unit home. In mid-range areas such as Boston and Minneapolis, a two-unit home has an FHA loan limit of $986,400, which is also the maximum amount in high-cost loans areas such as the New York City metro area, Washington, D.C., and San Jose, Calif.

Just don’t call it an investment property

This housing hack may sound like you’re turning your home into an investment property, but technically you aren’t. By listing the home as your “primary residence,” meaning you live there most of the year, you can qualify for the lowest mortgage rates such as FHA loans, which require living in the property you’re buying.

If it’s listed on the loan as an “investment property,” it’s illegal for the owner to live in it and getting an investment loan on that property would constitute occupancy fraud, says Michael Kaufman, a mortgage broker at R&J Capital Group in Forest Hills, NY. Even if there are tenants in the other units, it’s not technically an investment property, Kaufman says.

While an FHA loan can require a down payment as low as 3.5 percent, a loan for an investment property can require 20 percent down and have a much higher interest rate because it’s considered more risky by lenders.

If the home is a mixed use property, such as a building with a store below and an apartment above, that’s usually considered a commercial loan, he says. “If you occupy the apartment and rent out the store, you’ll need a lease to give to the lender,” Kaufman says.

Counting rent toward a mortgage

To deal with potential vacancies, most lenders will only allow 75 percent of the rental income to be used in paying a mortgage. If it was an investment property that the owner doesn’t live at, many lenders will take 100 percent of the income, Kaufman says.

If you don’t already have tenants, a lender may want signed leases to prove rental income if they’re giving you credit for it when calculating your monthly income, he says. Appraisals will report on if there’s the appearance of active renters or not.

“There’s definitely a risk involved,” Kaufman says. “You have to measure that and take it into consideration.”

But even if the income from renters covers your entire mortgage, a lender will want the owner to have some skin in the game financially, he says.

A higher down payment isn’t needed and rental income can lower a borrower’s debt-to-income ratio, possibly making it easier to be approved for a loan, Kaufman says.

Two-unit homes are the easiest to finance with an FHA loan, while three to four units requires having three months of payment reserves and passing a self-sufficiency test where rents have to cover the mortgage, says Alex Daniel, a mortgage lender in Los Angeles whose first home was a duplex that he rented had a renter cover everything but $650 of his mortgage each month.

The joys of being a landlord

Being a live-in landlord means living near your renters. That can be good and bad — such as if they’re having a loud party and you have to go tell them to quiet it down. And, of course, there’s maintenance, which can require being handy if you want to save money and do the work yourself.

Riley Adams, a licensed CPA in Louisiana who has a personal finance blog aimed at helping young professionals find financial independence, says he spends four to eight hours per month maintaining or repairing the two-unit house that he and his wife own in New Orleans, and another four to eight hours each month to upkeep a short-term rental behind the house.

The couple lives in one part of the house, and long-term tenants live in the other half. Adams’ part of the house has a separate side entrance. A separate unit behind the house earns them income as a short-term rental on AirBnB.

“Between the money earned from our tenants and the short-term guests who stay with us, we completely cover our monthly mortgage and associated housing expenses,” Adams says. “This allows us to live in the space for free and ‘house hack.’”

They used a traditional 30-year mortgage to buy the property, and included the expected rental income in their income total used to qualify for the loan, he says.

They keep busy during busy tourist times in New Orleans of November through May, he says, and both he and his wife are flipping the unit between guests.

“Living for free makes all of this worth it, however,” Adams says. “This allows us to save for a down payment on our place together in the future.”

If you don’t want to deal with possibly getting midnight calls from tenants, chasing rents and potentially having your property trashed from someone who has 24-hour access to you as a landlord, you can hire property management company to oversee the other unit, suggests Shawn Breyer, owner of Breyer Home Buyers in Atlanta.

By not dealing directly with tenants yourself and giving that work to someone else, you give the illusion to tenants that you’re also tenants, says Breyer, who worked it out with the property management company that he’d be there when applicants were touring the property.

“This allowed us to do extra vetting on the people living next to us,” he says. “Since we were able to help pick tenants and not have to manage them, this made house hacking a duplex much more enjoyable.”

Seek legal advice

Some real estate transactions can require a review by a lawyer. Becoming a landlord is one of them.

Kaufman recommends creating an LLC, or limited liability company, to protect you from being personally liable for the company’s liabilities. “This gives you a layer of protection against lawsuits which, as a property owner, can be debilitating to your overall worth,” he says. “If your personal name is on a deed and you’re sued as a property owner, your entire net worth is potentially in play to satisfy court ordered payments.”

An LLC can limit your liability to just those assets held under the entity, he says. A real estate attorney can help.

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