The three greatest costs of the average American are food, transportation, and housing. What if you could knock the largest expense in your life completely out? That line probably sounds like one of those late night scammy real estate gurus trying to sell you a $20,000 weekend seminar, but it actually can be done. If you are in the market to buy a home this is a great option and is a concept that can increase your stash flow thousands of dollars a year. In some cases you actually make money!
The technique is called house hacking. House hacking makes you think in terms of an investor and if your goal is to increase your stash flow this will help it grow quickly. This is a perfect strategy for someone looking for a ‘starter home’. You look at your living situation in a different light than everyone else, which is a great advantage. You begin by buying a starter home. A starter home implies that you will be upgrading to a bigger house in the future. House hacking gives you the chance to do that but you have a chance to make money on that starter home long after you move out.
In a typical house hacking situation you look for small multi-family homes, best case scenario is a duplex, triplex, or quadplex. You live in one of the units and rent the other units to tenants. The rent you gather covers the cost of your unit so in essence you are literally getting paid to own your own home.
Say whaat?
Here’s an example: Johnny Twotimes is ready to buy his first house. He’s been saving for quite some time and has done the research on the market. He has two options.
His first option would be to buy a condo or house that most would call a starter home. Let’s say he pays $150,000 and the property carries a $950 mortgage that will be an investment of his hard-earned cash towards his future. I mean Mr. Twotimes has his stuff together, right?
Johnny’s second option is to buy a triplex (three units side by side) for $150,000, live in one unit, and rent the other two units out to tenants for $900. Now these tenants are paying his mortgage and their hard-earned money is going towards Johnny’s future.
Where to find these properties…
When thinking about buying a new home, always consult a real estate agent. They will have a boatload of knowledge that you would otherwise is not available for you by searching on your own (unless this isn’t your first rodeo). On top of that they are Free (my favorite number) for the buyer of the home. The seller usually pays the agent their earned commission. Additionally, they have access to the MLS (Multiple Listing Service), which can hold the secret real estate treasures that you and I cannot access (unless you have a real estate license).
If you are always yelling at the gosh darn neighbor kids to get off your lawn, you probably don’t want to live near a school or a playground and an agent can help with that. Just make sure you hire a knowledgeable agent for the area in which you are looking. The jackpot is a real estate agent who has dealt with investors who share your same goals.
If you are just browsing for kicks, I would look at using Realtor.com, as it has been recommended to me by real estate agents to be the most accurate (at least in our area). But if you like saying the word Zestimate as much as Buddy the Elf likes saying Francesca, than Zillow will work too.
Remember, you’re looking for a duplex, triplex, or quadplex. Anything beyond that is considered commercial real estate and not something in which you want to dabble as a new investor.
The Bob Barker Rule
The price must be right. Keeping your emotions out of this purchase is another key factor to your success. If your budget is $150,000 then do not go a penny above that number. I know, I know, the kitchen is the size of a football field, and there’s a deck that you can see yourself grilling the finest meats, but it is important that you stick to your budget.
A good rule of thumb throughout many real estate communities is the 50% rule. This is where you take 50% of your gross income for various expenses that the home will need. Cashflow is king and this rule is a great way to evaluate if the property does in fact meet your goal criteria.
So, Johnny Twotimes is back (gold chains and all). He receives $925 per unit or $1850 a month in gross rental income. He saves 50% for all expenses associated with the property so he has $925 left to pay his $950 mortgage. A $25 a month living expense sounds pretty good to me!
Option 2:
If managing multiple units doesn’t fit your fancy but you still want to live the low-rent lifestyle, there is another way to save on your mortgage.
You can buy a single-family home or townhouse and rent it out rooms to slash your home costs. It is not that you are living with roommates, but that you are realizing opportunity cost associated with renting out rooms. This can easily save you $20K plus on a mortgage every 2 years! That is $20K that you can put towards your financial goals. You just gave yourself a $10,000 per year raise!
Okay, this all sounds fine and dandy but how do I finance these puppies?
If you are a first time homeowner but have not saved a bundle to buy a home, you can look into an FHA Loan (available at most banks). FHA stands for Federal Housing Administration (in case anyone needed a good yawn) and it was created to stimulate the housing market by making it more affordable. With an FHA loan, you only have to put 3.5% down. So if the home costs $100K you only have to put down $3,500 to seal the deal. If you want to reduce your monthly payments, you can also go with a conventional mortgage (what i did on my home) and put 10%-20% down.
If you are in fact new to this, I would consult a mortgage broker, as they can walk you through the steps to get the right financing option for you. I felt much more comfortable using a mortgage broker when I bought my home as they negotiated rates with various banks to get me the best interest rate possible.
Conclusion
House hacking is a great way to steadily build wealth. Instead of paying someone else’s balance sheet (renting), why not have someone else pay yours. It is something that you can do over and over again to build a large real estate portfolio. I recommend it to any first-time home buyers to get their real estate journey cash flow positive. We can virtually high-5 about all the money you’re saving later.
Andrew is the host of The Personal Finance Podcast, a show that is changing the way you think about your money. His primary goal with the podcast is to bring as much value as possible to his listeners.
Andrew's favorite free financial tool he's been using since 2014 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
His favorite investment platform is M1 Finance, a site that allows him to build a custom portfolio of stocks for free. It has no trading fees and is his preferred way to invest without having to lift a finger.
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