House Hacking
Since the Feds lowered rates, we have seen mortgage and refinance rates drop (they don’t always)!
However, this may mean that home prices may be rising again, so I love thinking about real estate in different ways, which means…house hacking.
House hacking is a powerful real estate strategy where homeowners leverage rental income to offset their living expenses. This method can significantly reduce your monthly housing costs and, in some cases, even generate additional income. In this blog post, Adam Coleman explores house hacking and dive into various mortgage options.
What Is House Hacking?
House hacking involves purchasing a property with multiple units or renting out part of your home to cover a portion of your mortgage payments. Common strategies include buying a duplex, triplex, or quadplex, or renting out a room in a single-family home. The goal is to leverage rental income to reduce your own living expenses or create extra income.
Mortgage Options for House Hacking
When considering house hacking, you have two primary mortgage options: FHA loans and conventional loans. Each has its own set of advantages and disadvantages.
Conventional Loans
Pros:
Lower PMI Costs: Conventional loans can have lower private mortgage insurance (PMI) costs compared to FHA loans for people with excellent credit
Temporary PMI: PMI can eventually be removed on conventional loans
No Self Sufficiency Test: Conventional loans don't have the same requirement like FHA where estimated rental income has to be greater than the mortgage payment
Cons:
Higher Interest Rates: Conventional loans may come with higher interest rates compared to FHA loans, impacting your monthly payments.
Stricter Qualification: Conventional loans often have stricter credit score and debt-to-income ratio requirements.
High Down Payment: Conventional loans typically require 5% down versus 3.5% for FHA
FHA Loans
Pros:
Lower Down Payment: FHA loans allow for a lower down payment (3.5%), making them more accessible for first-time homebuyers and investors.
Lower Rates: FHA loans usually have lower interest rates , especially for people with less than perfect credit
More Lenient Qualification: FHA loans are generally easier to qualify for, especially with lower credit scores.
Cons:
Higher PMI Costs: FHA loans include a higher mortgage insurance premium (MIP), which can increase your overall monthly payment. MIP also doesn't drop off once you hit 80% loan to value like it can with a conventional mortgage.
FHA Self-Sufficiency Test: This test determines if the rental income from the property will cover the mortgage payment and other expenses, ensuring that the borrower is not over-leveraged. FHA requires that 75% of the property?s estimated rental income should cover the mortgage payment (including principal, interest, property taxes, insurance, and MIP).
Negative Perception: Realtors will sometimes look at FHA mortgages negatively compared to Conventional loans, which might cause your offer not to get accepted
**Did you Know? The conforming loan limit for most counties in the US for a single family home is $766,550. For a 4-unit property, you can actually go all the way up to $1,474,400. In the highest cost areas (i.e. parts of CA, DC, NJ, NY, VA, etc), you can actually do a conforming loan up to $2,211,600 on a 4-unit property!
Cost Analysis: FHA vs. Conventional Loans
Let’s compare the costs and potential equity gains of house hacking with a conventional loan across different property types: single-family home, duplex, triplex, and quadplex.
This assumes you have the same $50,000 to put as a down payment for all options to better compare apples to apples. It makes some general assumptions (7% rate, 1% property tax rate, excellent credit, 3% home appreciation rate, estimated $2,000 a month in rent per unit).
With the rental income from the other units, the net monthly expense for housing is less as you do more units even with the much larger price and loan amount. That's a potentially huge benefit just reducing your monthly expenses, but the bigger benefit comes from the increase in equity you would get based on average home value appreciation. You could have double the amount of equity with a 4 unit property versus the single family even after just 10 years of ownership while paying $1,000 less in housing expenses each month, based on this example.
Another often forgotten benefit of this method is the potential tax break you could get. Unlike a single family primary home where you might get to deduct mortgage interest and property taxes, house hacking (and real estate investing) opens up a lot more options on the rented units including the same mortgage interest and taxes but also depreciation, repairs, insurance premiums, utilities, HOA fees and more.
And now with an FHA loan. Please note that you won't qualify for the 3 or 4 unit options because they don't meet the FHA self sufficiency test where 75% of the rental income ($2,000 per unit) is less than the total mortgage payment. In this scenario, you would have to do a conventional loan instead of FHA, so the 3 and 4 unit examples are just for comparison purposes and to illustrate the problems faced with the FHA Self Sufficiency Test.
Conclusion
House hacking can be a strategic way to minimize your housing expenses or even generate additional income. By analyzing the costs and potential equity gains of different property types and mortgage options, you can make informed decisions that align with your financial goals.
When considering FHA loans, remember the self-sufficiency test, which ensures that the rental income will cover a substantial portion of your mortgage and related expenses. Whether you choose FHA or conventional loans, house hacking offers the potential for significant long-term benefits, including reduced living costs and increased property equity.
Feel free to reach out if you have any questions or need personalized advice tailored to your situation!
Adam Coleman, CDLP�, AFC�
Branch Manager / Senior Mortgage Planner
Certified Divorce Lending Professional�
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