House hacking is a popular way for investors to get started in rental property without much capital.

When house hacking you can live in an especially expensive area you couldn’t afford otherwise. Here we’ll explain the concept and explore whether it may be right for you.

What Is House Hacking?

With house hacking, an investor finds a duplex or other multi-family property and charges rent for each unit except one — in which they live in as their primary residence. Another way to house hack is to purchase a home in need of repairs as your personal residence, and live in it while making repairs in order to sell in a couple years.

How Does House Hacking Save You Money?

House hacking can not only help you purchase an investment property that would otherwise be out of reach, it can also save you money If done well, monthly rent from the occupied units pays all the bills for the property, including the mortgage. This means you can live rent-free — and use that freed-up cash to save for another property — all while building equity. You may even get paid to live there if your monthly cash flow is greater than your expenses. Note that this strategy wouldn’t work for something like a vacation rental or rental arbitrage – you must live in the house and passively pay off the mortgage to effectively house hack.

How Do You Know a House Hack Is Profitable?

When house hacking, it’s important to find a home in a good neighborhood — especially if you’re going the single-family home route and hope to sell in a couple years. Ideally, for a multi-family property, you find one that can be improved upon — either by increasing rents, decreasing expenses, adding space through an addition or finished basement, or increasing its value through major repairs like a new roof. You may wish to search for a multi-family property that has one unit that is immediately ready for tenants so you can start generating income from day one, but this may be a diamond in the rough.

Through these tactics, you’ll increase the value of your property through forced appreciation — appreciation based on specific improvements and renovations to the property.

In addition to appreciation, think through what your monthly cash flow will be once you decide to move out of the property yourself. Even with an FHA loan, after one year has passed, you’re allowed to move on without any changes to your loan. You may wish to do this in order to perform another house hack, or to simply have your own stand-alone residence.

A good rule-of-thumb when purchasing a property is the 1% rule. Find a property that you can charge at least 1% of the purchase price in monthly rent. If you spend $300,000 on a triplex, you should be able to get $3,000 in monthly rental income — or $1,000 for each side. Since you’ll initially be living rent-free on one side, you won’t realize this full amount until you fully rent the property, but it's good to make sure the property cash flows by itself in the future. While the 1% rule is good for quickly ruling out potential buys, always run a more specific cash flow estimate on the property before you purchase.

Is House Hacking Good for First-Time Home Buyers / Investors?

House hacking is an excellent way for first-time home buyers or investors to get started in real estate. Many have a hard time saving the required 10% to 20% as a down payment for their first home or investment property. By opting for a Federal Housing Association (FHA) loan — which we’ll discuss next — you may be able to get the property for as low as 3.5% down.

Plus, house hacking provides a low-risk primer in landlording. Since you’ll be living in it, you’ll have intimate, daily knowledge about the property and its tenants. You’ll learn how to get and effectively screen tenants, make rental agreements, handle maintenance issues, and keep accurate bookkeeping records.

What Are the Best Mortgages for House Hacking?

As we mentioned before, by choosing to finance through an FHA loan, you can get a property for just 3.5% down. This allows investors or first-time home owners to purchase a home who otherwise wouldn’t have the funds to do so. Since non-owner-occupied properties will increase your mortgage interest rate by a percentage point, by living in your house hacked property, you’ll also save on interest by qualifying for the lower, owner-occupied interest rate.

It’s important to note that you must occupy the property as your personal residence for a minimum of 12 months, the loan amount may have a limit depending on where you live, and you’ll likely have to pay a mortgage insurance premium (MIP) for the life of the loan — similar to private mortgage insurance (PMI).

If you’re a veteran, you may qualify for a VA loan and pay nothing at all in a down payment and with better terms. You’ll still have to owner-occupy the property and pay PMI for the entire length of the loan.

To get started in house hacking, review as many properties as possible to find the best fit for your skills. You may also wish to employ the help of a discount real estate agent experienced in your area or network with other investors in your area.

Dr. Francesca Ortegren, Ph.D. is a Research Associate at Clever Real Estate where she focuses on helping people understand complex data, real estate, finances, business, and the economy by researching various topics, analyzing data, and reporting useful insights for general consumption.