What Is House Hacking and How Does It Work?

House hacking is a real estate strategy where an individual purchases a property, lives in one part of it, and rents out the remaining units or rooms to generate income. This approach aims to offset or substantially reduce personal housing expenses, such as mortgage payments, property taxes, and insurance. It can also function as an entry point into real estate investment.

Understanding House Hacking

The fundamental idea behind house hacking involves an owner-occupant residing in a portion of their property while leasing out other sections. Rental income from tenants can then cover a significant portion, or even all, of the owner’s housing costs.

This strategy applies to various property types beyond single-family homes. It includes multi-unit dwellings like duplexes, triplexes, or quadplexes, where the owner occupies one unit and rents out the others. It can also involve single-family homes where spare bedrooms or converted spaces are rented to tenants. The key distinction from a typical landlord-tenant relationship is the owner’s continuous residency on the property.

Common House Hacking Strategies

One strategy involves purchasing a multi-unit property (duplex, triplex, or fourplex) and residing in one unit while renting out the others. This setup typically features separate entrances, individual utility meters, and distinct living spaces, allowing for clear separation between the owner’s residence and rental units.

Another approach is renting out spare bedrooms within a single-family home. The homeowner lives in the house and leases out one or more bedrooms. This usually involves shared common areas like the kitchen, living room, and bathrooms, requiring clear communication regarding shared space usage.

A third method utilizes an Accessory Dwelling Unit (ADU), a separate living space on the same property. This could be a converted basement apartment, a garage conversion, or a newly constructed detached unit. The ADU typically includes its own kitchen, bathroom, and sleeping area, allowing the owner to live in either the main house or the ADU and rent out the other.

Other variations include renting non-traditional spaces like a garage or shed, or using a portion of the property for short-term rentals. These methods leverage existing property space to generate income. Each strategy requires careful consideration of the property’s layout and local regulations for feasibility.

Financial Impact of House Hacking

House hacking directly impacts an owner’s finances by using rental income to offset housing expenses. Income from rented units or rooms can be applied towards the monthly mortgage payment, property taxes, and homeowner’s insurance premiums. This reduces the owner’s out-of-pocket housing costs, potentially freeing up funds for other financial goals.

Initial financial commitments include down payments and closing costs. For owner-occupied multi-unit properties (up to four units), government-backed loans like FHA loans can require down payments as low as 3.5%, while conventional loans may require 5% or more. Closing costs typically range from 2% to 5% of the loan amount, covering fees such as loan origination, appraisal, and title insurance. Renovation expenses to prepare units for rental also represent an upfront cost.

Ongoing operating expenses include routine maintenance and repairs, utilities (if shared or included in rent), and potential property management fees. These expenses reduce the net rental income available to offset housing costs.

For tax purposes, rental income must be reported on IRS Schedule E, “Supplemental Income and Loss.” Property owners can deduct ordinary and necessary expenses incurred in managing and maintaining the rental portion of their property. Deductible expenses may include mortgage interest, property taxes, insurance premiums, repairs, and property management fees. Depreciation is another deduction, allowing owners to recover the cost of the building (excluding land value) over its useful life, typically 27.5 years for residential rental property.

Important Considerations for House Hacking

Before house hacking, research local regulations and zoning laws. These dictate what types of properties can be used for multi-unit dwellings or accessory dwelling units and may have specific requirements for renting rooms. Homeowner association (HOA) rules also need review, as they can restrict rental activities.

Understanding lender requirements for owner-occupied properties is important. Mortgage programs, such as FHA or conventional loans, have specific down payment minimums and occupancy clauses requiring the owner to live in one unit for a certain period, often at least 12 months. Lenders may also consider a portion of projected rental income when determining loan qualification.

Evaluating a property’s physical suitability for house hacking is a practical step. This involves assessing if the property has features like separate entrances or can be easily modified to create distinct rental spaces. Considerations such as adequate parking and soundproofing are also relevant for tenant comfort and privacy.

Familiarity with local and state tenant-landlord laws is important. These laws govern lease agreements, security deposit handling, eviction procedures, and tenant rights regarding privacy and habitable living conditions. Adhering to these legal frameworks helps ensure a compliant and professional landlord-tenant relationship. Individuals should also consider the personal lifestyle adjustments that come with living alongside tenants, including potential impacts on privacy and the responsibilities of being a landlord, such as managing repairs and addressing tenant concerns.