Want to make the move to owning a home, but worried that the monthly mortgage payment will be too much of a burden? Then maybe it’s time for a bit of house hacking.
What’s that? It’s when you buy a multifamily property, live in one unit and rent out the others. You can also convert a single-family home into a multifamily unit, creating what is often called an in-law unit, say, on the top floor and renting that space out while you live in the bottom half of the building.
House hacking can work with duplexes and multifamily buildings that come with more units. The goal is to earn enough from the rent you collect to either cover the entirety of your monthly mortgage payment or most of it.
Be careful, though: House hacking when done right can help turn you into a homeowner. But being a landlord also comes with plenty of challenges to overcome.
What are the potential pitfalls? Here are several to avoid.
Morgan Franklin, a real estate agent with Atlas Trust Real Estate in the Lexington-area community of Nicholasville, Kentucky, said that she has seen a steady stream of younger buyers purchasing multifamily properties with the goal of using rental income to cover their monthly mortgage payments.
There are potential challenges, though, Franklin said. Affordable rental properties, properties in which owners will have a low-enough mortgage payment to make house hacking make financial sense, often sit in neighborhoods that aren't hot or desirable. These neighborhoods might not feature the restaurants or shops that buyers often want. They might have higher crime rates, too.
Having to live in a neighborhood that lacks entertainment, dining or recreational amenities might remove some of the luster hacking that house, Franklin said.
"Be sure you will be happy living there," she said. "If you are, it will be well worth it when you don't have a mortgage or rent payment."
Then there are boundary issues. When you rent a space in your home, your tenants will also be your neighbors. They might come knocking on your door at night asking for plumbing help or complaining that their apartment isn't warm enough.
Franklin says that owners must set proper boundaries to prevent these disturbances. It’s not unreasonable that your tenants contact you if their hot water isn't working or their kitchen sink is leaking. But you need to set up a process for complaints that doesn't involve your neighbors pounding on your door at all hours of the day.
This often means hiring a property management company that will respond to neighbor complaints. Your neighbors will simply contact this company when they need help. The downside? Property managers aren't free, and the fees they charge could reduce the savings you realize by renting out space.
Insurance issues, down payment dollars and interest rates
Franklin recommends, too, that owners consider insurance issues. It typically costs more to insure a multifamily property. Make sure, though, to inform your insurer that you are living in the property, too. Your insurance coverage might cost less if you are also occupying the space.
Insurers believe that when owners live in a property, they'll pay more attention to it, reducing the likelihood that they'll have to file expensive claims for fires, water damage and other disasters.
Expect to pay higher mortgage rates, too. Franklin said that mortgage lenders charge higher interest rates for multifamily properties than they do for single-family residences. There is a ray of hope here, though: If you tell your lender that you will live in the property, too, you might have to come up with a smaller down payment.
Buyers often must come up with a down payment that is 15 percent to 25 percent of the property's cost when they are buying a multifamily property, Franklin said. But if buyers are living in the property, they might be able to qualify for a lower down payment of 3.5 percent, if they qualify for an FHA loan, or 3 percent if they qualify for a Fannie HomeReady loan.
Don’t follow the rules? That can hurt
House hacking can be profitable. But it can also lead to legal problems and fines if you don't do it right. And that starts with choosing the right property.
Brad Srutowski, a real estate agent with Hot Properties Real Estate in Norco, California, said that owners must first check their local zoning ordinances to make sure that multifamily properties are allowed in their areas. If they aren't, then hacking a house won't work.
Owners that ignore zoning requirements could face legal action if they are found out, Srutowski said.
Maybe you've hacked your garage, turning it into a bedroom to rent. This usually isn't legal, Srutowski said, and it can result in fines from your local municipality. You’ll also have to stop renting out the space once your municipality discovers what you’ve done.
And that might be just the start of your problems. If your tenants injure themselves while living in a hacked space that doesn’t meet local codes? You could easily lose a lawsuit, Srutowski said.
“Want to talk about a property lawsuit that will likely be a slam dunk in favor of the plaintiff?” Srutowski asked. “That is a great way to start.”
Budget for repairs
Repairs can be a challenge, too. Inevitably, something will go wrong with the space you are renting to tenants. The refrigerator might go on the fritz. Maybe the bathroom sink will spring a leak. As the landlord, you're responsible for fixing all this.
It's essential, then, that you set aside money to cover these repairs. Srutowski recommends that you put at least 10 percent of collected rents into an account that you can draw from to pay for unexpected repairs.
Keep these unexpected expenses in mind, too, when you are calculating your budget. You might think your tenants' rent will cover your mortgage. But this might not be the case if you must shell out a significant amount of money on repairs each month.
"People don’t realize just how expensive it is to do maintenance on their own home, and this is all multiplied two or three times when you have a multifamily property," said Eric Bowlin, the Plano, Texas-based founder of IdealREI and the owner of more than 470 units of rental property.
Bowlin recommends that owners who are living in a property that they are also renting out should budget 40 percent of their total rent revenue for expenses. This figure includes maintenance, water, sewer, electricity, insurance and taxes.
Capital improvements can bust your budget
Owners often forget, too, to budget for major capital expenditures, Bowlin said. They don't set aside money for repairing old roofs, replacing burst water heaters or upgrading inefficient HVAC systems.
"The reality is, the major items will go at or around the same time," Bowlin said. "The HVACs were all the same model installed at the same time by the same guy, so chances are they will go at the same time. You need to budget and save for this certainty."
How much time do you have?
Paul Rotondo, a real estate agent with Elite Realty Advisors in Norwell, Massachusetts, said that people often underestimate the work that goes into renting out a portion of their living space.
This work involves everything from screening potential tenants to having to evict those who don't pay their monthly rents. It also involves hiring a property management company, crafting a well-written lease and marketing the property whenever it goes vacant.
None of this is easy, and might outweigh the rental income that hacking a house generates.
"Can the owner deal with constant damages, high turnover and the sheriff on speed dial?" Rotondo asks.
This doesn't mean that hacking your house isn't worthwhile or that it’s not possible to successfully cover your mortgage payment by doing so. Rotondo said that owners who craft a clear lease that spells out the duties of both tenants and landlord, will have an advantage. And if you maintain your property well and follow through on your own promises, you will generally gain the respect of tenants, Rotondo said, making it more likely that they won’t damage your home and will pay their rent on time.
"Basically, you can't be too nice," Rotondo said. "The nice guy factor is lethal."