Ready to start your own rental empire? The first step is to buy a property with more than one unit. For the average American, one of their biggest expenses is their mortgage payment, or their rent. According to the Bureau of Labor Statistics, roughly half of the typical American’s expenses come from just two categories – housing and transportation (excluding taxes), with 33% of total spending on housing alone. This payment is holding them back from accumulating significant savings, and the financial freedom that more capital to invest could provide them. What most people don’t know, is that this payment is optional. It’s possible to own your own building for less than $10,000 down, and never have to make another payment again. It’s not easy, and you’re going to have to put in a lot of sweat equity, but it will save you hundreds of thousands of dollars over 30 years. This investment is called a house hack. If you’ve never heard of house hacking, pay attention.
The concept of house hacking is simple. You buy a duplex, triplex, or quadplex with an FHA loan (3.5% down), and your tenant’s rent covers all or most of your mortgage and other expenses. If it’s done right, you can drastically increase your available capital for investing every month. If it’s done wrong, you can purchase a money pit of a property that’s hard to manage and will cost you more than renting. If you’re not willing to take a bit of a risk, this investment probably isn’t for you. For whatever reason, the FHA, and even the VA, considers any property with four units or less as a single purchase. This means you can buy a duplex, triplex, or fourplex with an FHA loan or a VA loan. In order to qualify, you have to live at the property, using it as a primary residence. That’s where the multi-unit part of the plan comes into play: You live in one of the units and rent out the rest.
It’s one of the easiest and most efficient means one can use to move towards early financial freedom while working a full-time job. In this situation, the owner now has a stabilized property that allows him/her to live for free, still have capital to repair their building as needed and is now free to invest what they would have been spending on rent. In fact, in a year or two, the owner can refinance into a traditional mortgage, and house hack a new property. You might be able to continue to acquire a rental property capable of sustaining early financial freedom in less than 10 years, depending on the market and real estate cycle. And, it’s no harder to buy a house-hack than it is to buy a home, financially speaking. It’s important to note that older building with major capital expenditures coming soon might be have enough cashflow to breakeven so looking for a with newer plumbing, electrical, sewer, HVAC, and a new roof.
Can you buy a second FHA home?
Once you are stable with your first property, you might want to purchase another property to rent out or move into. In this scenario, it’s tempting to use the FHA program again. However, that option may be limited.
You can obtain a second home, but it’s done on a case-by-case basis. You usually need to show need, such as relocating for a job, or prove that your expanding family can’t fit into your old home anymore.
FHA loan requirements are also such that you might not be able to count the income you receive from your rental property in your application. Unless you have 25 percent equity in your home, your income from renting out an FHA home might not be taken into consideration.
For many people, though, living in that first FHA property provides them the resources they need to take the next step. If your tenant is covering your own housing costs, that can help you build a large fund to use as a down payment on another property down the road.
You can use a program like FHA loans to get started as a landlord. It takes a couple years to really get going, but it’s one way start the process immediately — even if you don’t have a lot of money.
Finding Your House Hack
Finding a good property to house hack isn’t easy, but it can be done if you’re persistent. Have strict parameters. For example, don’t look at a property unless the total rent is at least 1% of the purchase price of the building. Ideally, closer to two percent, but a 1% deal can still cash flow. In certain markets, like St. Louis, it’s possible to find deals closer to 2 or 3% price to rent, but that might not be in an area you want to live in or manage. If you’re starting out, interview several realtors, and find one that has experience working with investors, and ask them to help you find your first property.
Your realtor should set you up with MLS alerts, so every deal that meets your criteria will be sent to your email. If you like a property, it’s time to schedule a showing. When you view a new property, be sure to inspect the following:
• Age of the roof
• Major cracks
• Water in the basement
• Do doors and windows open easily?
• Condition of the windows
• Is any paint peeling
• How nice are the kitchen and bathrooms (these rent houses)
It’s unlikely that you’ll find a property at a good price where all of these are in good condition, so you need to budget the cost of repairs into your projections. After you view a building you can make an estimate of the major repairs that will be needed, and make a more accurate model of how much to save for repairs and maintenance every month. While it’s very tempting to offer on a nice property, you can’t get emotionally invested. This is a business, and needs to be treated as such. Only buy something that makes a lot of sense on paper, because it’s probably going to do a lot worse in reality. You want an investment with enough margin for things to go wrong and you still end up OK. Buying a property that barely cash flows on paper is a recipe for disaster. Once you’ve found your property, a good agent will help you make the right offer. Be sure to include a personal letter to the owner for every offer that you make. If two offers are equal, the offer with a convincing letter is probably going to win the house. You can reuse the same letter on every house you offer on, and just make minor tweaks based on the situation. Assuming the offer is accepted, you’re officially under contract!
Financing: Know FHA loan requirements
Before you commit to house hacking, it’s important to understand what happens when you use FHA loans to buy properties. You can make this strategy work with just about any type of loan. However, FHA home loans are especially good because of the low down payment option. With this type of loan, you can pay as little as 3.5 percent for a down payment. For many people, that’s much more affordable than trying to come up with 10 or 20 percent to put down.
On top of that, FHA loan requirements are more flexible when it comes to your credit. It’s possible to qualify for 3.5 percent down with a credit score as low as 580. Even though it helps to have good credit, you can still become a landlord with less than perfect credit. There are limits to how much you can borrow. The FHA sets loan maximums based on home prices in the area. It’s done on a county-by-county basis, so talk to a mortgage professional about the limit in your neighborhood. Depending on the FHA loan limits and the cost of properties, you might be limited to a duplex for your first house hacking experience.
Next, you need to commit to living in the home for at least year. You must also move into the home within 60 days of closing.
Finally, you need to make your FHA loan payments on time and in full each month. I recommend saving up a buffer fund. That way, if your rental unit is empty for a few months, your finances aren’t strained. I can’t stress enough the importance of being able to afford your mortgage, even if you plan to rent out the other unit(s). Financing for a house hack is a bit more difficult than a conventional loan. FHA properties have to pass a more rigorous inspection, and peeling paint isn’t allowed. While this can limit some potential deals, it’s possible to do the work before you close, or use an FHA 203k renovation loan. A good agent and lender will be able to help you navigate through the FHA financing process. Before you schedule any showings, it’s important to get pre-approved, or your offers won’t be taken seriously.
Why House Hacking is so Awesome
Buying an owner-occupied investment property and renting out the additional bedrooms and/or units is probably the single most effective hack that a median wage-earner can make to begin moving towards financial freedom rapidly. It takes the largest expense in your life and wipes it out entirely. Why would you bother to remain disciplined day in and day out with the fun stuff in your life, when you can automatically save yourself tens of thousands of dollars per year through the combinatorial benefits of house hacking?
House hacking leaves the purchaser with three excellent options if done correctly:
1. It allows the house hacker to live happily at low cost indefinitely.
2. It allows the house hacker to move away and retain the property as a cash flowing rental.
3. Like every homeowner in the country, the purchase retains the right to sell the property.
Few people have all three of those excellent options. Few people are able to move anywhere they want at a moment’s notice and convert their home into an excellent cash flowing rental property. This is the ultimate low-risk, high-reward way to buy your first or next property if you aspire to early financial freedom and want to accelerate your wealth accumulation.