House hacking helps some buyers overcome financial challenges

Like many first-time homebuyers, fiancés Veronica Yam and Dexter Chan were frustrated after nearly two years of looking for a home. As home prices and mortgage rates rose and the number of homes for sale shrank, the couple decided to change their strategy. Instead of shrinking their search to smaller homes, they opted to look for something larger with space for a tenant whose rent could offset their mortgage — a technique many buyers call “house hacking.”

“Our budget for a starter home was between $600,000 to $700,000, but when we toured homes in that price range in D.C. or Northern Virginia, we found out that most of them weren’t up to the quality of the townhouse we’re renting,” said Yam, a nurse practitioner at George Washington University Hospital in D.C. “We were preapproved for a loan of more than $1 million, but we want to be careful with our spending.”

With a plan to bring in a tenant, they upped their budget and purchased a single-family home in Michigan Park in Northeast D.C. for $865,000.

Chan and Yam are part of a growing group of buyers who hope to make homeownership more affordable through house hacking. In a recent survey by Zillow, 55% of millennial homebuyers and 51% of Gen Z homebuyers said they think house hacking is a good path for homeownership. More than half of both age cohorts hope to transition the home into an investment property when they’re ready to move up.

Finding the right configuration for house hacking

House hacking can refer to any arrangement that includes a tenant, such as a housemate renting a bedroom, basement or apartment over a garage, or, on a bigger scale, leasing a second, third or fourth unit in a duplex or small apartment building.

While some homebuyers are fine with sharing living space with their tenants, others prefer to rent a section of their home that has a separate entrance.

Villy Iranpur, a real estate agent with RLAH @properties in Chevy Chase, Md. and a board member of the Greater Capital Area Association of Realtors, owned a two-bedroom condo in Rockville where she rented a room to a tenant and shared the kitchen and living space.

“Now I own a single-family home in Brightwood specifically because it has a separate basement that I rent to a tenant,” Iranpur said. “That way I have more privacy.”

When Thai Hung Nguyen, a real estate agent with Better Homes and Gardens Real Estate Premier in Falls Church, Va., and his wife purchased their first home, a three-level townhouse, they thought they would rent the lower level.

“The lower level had a bedroom and full bathroom, but we didn’t think ahead about the fact that it wasn’t closed off from the rest of the house,” Nguyen said.

They decided they didn’t want to live with a stranger in their home. In addition, as with many older homes, the laundry room was on the lower level.

Yam and Chan, a tech sales consultant who works in Tysons Corner, Va., looked in Northern Virginia and D.C. for a townhouse or single-family home with a separate entrance to a basement.

“A friend of ours bought a row house in D.C. that had space like that to rent for extra income through ‘Furnished Finders,’ which is primarily used by traveling health care workers for short-term rentals,” Yam said. “We wanted a location where we want to live most of all, but secondarily we thought about a location where people might want to rent our space, too.”

Their new house is 2,100 square feet with four bedrooms and three full bathrooms.

“We have family in the area and plan to stay here, so we’re happy to have a single-family home that we can grow into,” Chan said.

In the meantime, Chan said, they plan to add a kitchen counter with an induction cooktop to the wet bar in the basement, which already has a small refrigerator for tenants.

One issue they haven’t solved yet is laundry. Their washer and dryer are in the basement, which would be inconvenient when a tenant is in place, especially a long-term renter. They may add a second laundry set upstairs in the future.

“One of my clients bought a house in Herndon with a walkout basement with a separate entrance, a bedroom, a full bathroom to rent to a tenant,” Nguyen said. “That house has two sets of laundry machines. They had to bid up to buy it, but they found a tenant right after the closing to subsidize their mortgage.”

Working the numbers

Depending on the property, buying a home with a space to rent to a tenant is likely to cost more than one without rentable space. If you’re thinking of house hacking, start with a consultation with a lender and a preapproval for a loan to find out how much cash you need and to get an estimate of your monthly payments.

As long as you live in the home you’re buying or in one of the units if you’re buying a property with one more unit, you’re buying the property like any other buyer and not as an investor, said Jonathan Okun, a senior mortgage consultant with Prosperity Home Mortgage in Bethesda, Md.

“In the past, if you purchased a two-, three- or four-unit building, the lending guidelines were a little different, but now you can finance that kind of purchase with a conventional loan with as little as 5 percent down,” Okun said. “You can also use FHA financing with a down payment of 3.5 percent.”

While every lender has their own guidelines, sometimes buyers can include up to 75% of the anticipated market rate rent for the rental unit as income, Okun said. In other words, if the estimated market rent for the rental unit is $2,000, you could add $1,500 to your monthly income to qualify for the loan. However, lenders usually won’t count anticipated rent as income when plan to rent out your basement if it’s accessible from the interior of your home since that’s still considered a one-unit house.

“If you’re buying a multifamily home with two, three or four rental units, the loan limits are higher than they are for a one-unit home,” Okun said. “For conventional financing for a multiunit property, you need a credit score of at least 640.”

If you’re a first-time buyer with an income of under $180,000 in the D.C. area, you may qualify for a lower interest rate compared to a repeat buyer, Okun said. For example, a repeat buyer with a credit score of 640 and a down payment of 5 percent purchasing a four-unit building might have an interest rate of 7.5%, while a first-time buyer who meets that income limit might pay 6.375% with Fannie Mae’s program.

“If an appraiser says your home is a one-unit home, then you’ll finance the property under the usual guidelines,” Okun said.

The important step is to discuss all your financing options with a lender before assuming you can house hack.

Planning for landlord duties

While the financial benefits of house hacking are clear, buyers need to consider their lifestyle and other issues before committing to the plan.

“A big question is safety,” Nguyen said. “You need to screen tenants, especially when you’re sharing a home with them. Even if you’re renting to a friend of a friend, you need to check their background, pull their credit, and check that they have consistent employment and income.”

Nguyen said homeowners who rent part of their home should have a legal rental agreement that spells out what will happen if they don’t pay rent or move out unexpectedly. He recommends paying an attorney to write the agreement rather than relying on templates from internet sources.

“You need to be aware of tenant laws,” Nguyen said. “D.C. and Maryland have tenant-friendly laws that can make it harder to evict someone compared to Virginia, which has more landlord-friendly laws.”

Various jurisdictions have rules about what is required for a rental space to be legal.

“If you own a two-unit home, you need a certificate of occupancy to legally rent out the second unit,” Iranpur said. “In some places it can be hard to kick someone out if they don’t pay their rent, especially if it’s not a separate legal unit.”

Depending on the configuration of your home, it’s often simpler to include a share of your utility bills in the rent, Nguyen said. But he warns that you need to use the phrase “normal use” of utilities and specify which utilities are included in the rental agreement.

“The tenant of someone I know did bitcoin farming in his basement unit, which used about 10 times the normal amount of electricity,” Nguyen said.

Homebuyers intending to house hack also need to know about local ordinances and homeowners association rules that could impact their ability to have a tenant, Nguyen said. For example, in many places you’re not allowed to add a second kitchen in your basement, he said. Some homeowner associations restrict the number or type of cars you can keep on your property, too.

“When you house hack, you’re a landlord, so you need to be mindful of that responsibility,” Iranpur said. “It’s up to you as the homeowner to take care of everything.”

Part of the responsibility includes notifying your insurance company that you have a tenant, Nguyen said. He recommends requiring tenants to purchase renter’s insurance to protect themselves.

The bottom line: Go into house hacking with a full understanding of the risks and rewards.

“When you house hack, you should still buy what you can afford,” Nguyen said. “The income from your tenant should be a bonus, not something you must have to make your mortgage payment. There are so many things that can go wrong with a tenant, so you shouldn’t be overly dependent on them.”