House hacking: renting rooms or a duplex

In short

A friend of mine once told me he stopped thinking of his mortgage as a bill and started thinking of it as a shared expense. That is the heart of house hacking. You buy a home, live in one part of it, and rent out the rest, so someone else helps pay the loan. If you are holding a lease and wondering whether there is a better way, this guide is for you. The idea is simple, though the work is real. A lender will treat a one to four unit home you live in as an owner occupied loan, which often means a smaller down payment than an investment property. The rent you collect is income, and income gets taxed. Count every cost before you count any rent, and talk to a lender and a tax professional before you sign.

The whole of it

What it is

I once watched a young couple turn the basement of their small house into a rented apartment, and within a year they spoke about their loan the way you might speak about splitting a dinner check. That is house hacking in a nutshell. You live in the property, and you rent out a room, a basement, or one side of a duplex. A duplex is a building with two separate homes under one roof. Some folks go as far as a triplex or fourplex, which hold three or four homes.

It is an unconventional path, and that is worth saying plainly. Most people buy a house only to live in it. Here, you are also a small landlord. That means you take on a second job, whether you meant to or not. You answer the late night call about a leaky faucet. You screen tenants. You keep records. Some people love this and some find it wearing.

There are two common shapes. In the first, you rent out spare rooms in the home you live in, and your tenants share your kitchen and living space. In the second, you buy a building with more than one unit and live in one while renting the others. The first costs less to start and costs more in privacy. The second gives everyone their own door.

How it works

If you have ever shopped for a mortgage, you know lenders sort loans into owner occupied and investment. Owner occupied means the borrower lives in the home. These loans often carry a lower down payment and a lower rate than loans on rental property, because lenders see a person living in the home as a safer bet. A home with up to four units can still count as owner occupied, so long as the borrower lives in one unit.

The Federal Housing Administration, called the FHA, insures loans on one to four unit homes. Its minimum down payment is set by its own rules, so check the current figure with an FHA approved lender. The loan also carries mortgage insurance, which is a fee that protects the lender, and you pay it on top of your regular payment. The borrower must plan to live in the home as a main residence, and the loan terms spell out how long.

Lenders may count part of the expected rent when they decide how much you can borrow. Each lender sets its own method, and it often asks for a rent estimate from an appraiser or a signed lease. So ask early how your lender treats rental income.

Then there is the tax side. Rent you collect counts as income, and the Internal Revenue Service explains how to report it in Publication 527, Residential Rental Property. When you rent part of your home, you generally split costs between your own space and the rented space. You may deduct the rented share of things like repairs, insurance, and interest. Depreciation, which is a way to deduct the wear on a building over time, also comes into play, and it can change what you owe when you sell. A tax professional can walk you through it. I would not guess at this part.

The numbers, and where to find yours

Every house hacker needs a handful of figures, and I would rather you find your own than trust mine. Start with the minimum down payment for the loan you want. The FHA publishes its limit, so the number here is the current figure, which the official source publishes each year. Next is the loan ceiling for your county. The FHA sets a maximum loan amount by area, and for a one to four unit home it is the current figure, which the official source publishes each year. Look yours up on the Department of Housing and Urban Development website, known as HUD.

Mortgage insurance has its own price. The annual FHA premium is the current figure, which the official source publishes each year, and your lender will show it on your loan estimate. Then check what rent your area truly brings in. Look at the rental listings for similar rooms or units nearby. HUD also publishes fair market rents by area, which gives you a rough outside check.

Last, find your local rules. Some cities limit how many unrelated people may share a home. Some require a rental license or an inspection. Your city or county housing office can tell you. Skipping this step is a common and costly miss.

A worked example

Let me tell you about a woman I will call Maria Delgado. She bought a duplex for $300,000, lived in one side, and rented out the other. She put down 5 percent, so her down payment was 5 percent of $300,000, which is $15,000. That left a loan of $285,000. These are her own made up figures, picked only to show the math.

Her monthly costs came to $2,300. That covered the loan payment, property tax, insurance, and mortgage insurance. She also set aside $250 a month for repairs and $100 a month for the times the unit sat empty. That brought her true monthly cost to $2,300 plus $250 plus $100, which is $2,650.

Her tenant paid $1,500 a month in rent. So her cost after the rent was $2,650 minus $1,500, which is $1,150 a month. Over a year, that is 12 months at $1,150, or $13,800. Compare that with the $2,650 she would have paid with no tenant, which is 12 times $2,650, or $31,800. The rent covered $18,000 of the year, since 12 times $1,500 is $18,000.

Notice what Maria did not do. She did not count the whole $1,500 as free money. She held back $250 and $100 for the bad months first. And she remembered that the $18,000 in rent is taxable income, so some of it goes to the IRS, less her allowed deductions. A sharp reader will see that her real saving is smaller than $18,000 once taxes are figured. That is the honest picture.

Where it goes wrong

I have noticed that the people who struggle with this are rarely foolish. They are hopeful, and hope skips the boring math. The first trouble is a vacancy. A unit can sit empty for a month or three, and the loan payment does not pause. A thin cushion turns one empty month into a crisis.

The second is a bad tenant. A tenant who pays late, or not at all, can cost you months of rent and legal fees. Eviction rules differ by state and city, and the landlord must follow them to the letter. Screen with care, and use a written lease every time.

The third is repairs. An older duplex can hide a bad roof or old pipes. A home inspection before you buy is cheap next to a surprise bill. Fourth, the owner occupied loan comes with a promise. The borrower agreed to live in the home, and breaking that promise can have serious results with the lender. Read your loan papers.

Last, there is the cost to your peace. Living next to your tenant, or sharing a kitchen with one, is not for everyone. Think hard about that. Money saved is poor comfort in a home that feels crowded.

Questions to answer before you leave this page

Have you looked up your own down payment, loan limit, and mortgage insurance figures instead of leaning on mine? Do you know what rent similar rooms or units earn in your neighborhood, and have you tested your plan using only half of that rent? Could you carry the full payment for three months if the unit sat empty? Does your city allow what you have in mind, and does it require a license or an inspection? Have you asked a lender how it treats rental income, and a tax professional how rent and depreciation would hit your return? Are you ready to answer a tenant's call on a cold night, and would you honestly enjoy having a neighbor so close?