House Hacking: Buying a 2 to 4 Unit Property and Living in One Unit

House hacking means you buy a property with two to four units, live in one of them and rent out the rest. The tenants' rent covers some or all of your mortgage. You get your first rental property with owner-occupied loan terms, which are much easier to qualify for than investor loans.

It's one of the few ways to buy a rental with a small down payment, and it's the reason a lot of first-time investors start with a duplex.

Why the loan terms are better

Lenders treat a loan on a home you'll live in as lower risk than one on a pure investment. Two programs come up most:

• FHA loans allow as little as 3.5% down on a property of up to four units, as long as you'll live there. They carry mortgage insurance, which adds to the payment, and there are loan limits that vary by county.
• Conventional loans for an owner-occupied 2 to 4 unit property often need somewhere between 5% and 15% down, depending on the number of units and the lender.

Compare that with the 20% to 25% down most investor loans ask for, and on a US$260,000 duplex the gap is about US$9,100 down with FHA against US$52,000 to US$65,000 for an investor loan.

On FHA loans for three and four units, there's an extra test, and HUD sets it: 75% of the market rent from all units, including yours, has to cover the full monthly payment. Lenders may also count a share of the other units' expected rent as income when they decide whether you qualify.

The condition is that you move in, usually for at least a year. After that you can move out and keep it as a rental, and some investors repeat the process on the next property.

A worked example

Say you buy a duplex for US$260,000 with an FHA loan and 3.5% down, which is US$9,100 plus closing costs. You borrow about US$251,000, plus about US$4,400 of upfront FHA mortgage insurance rolled into the loan, so the loan is about US$255,000. At 7%, principal and interest comes to about US$1,700 a month. Add property tax of roughly US$240, insurance of US$75 and FHA mortgage insurance of about US$115, and the monthly payment is around US$2,130.

The other unit rents for US$1,300. Your cost to live there is US$2,130 minus US$1,300, or about US$830 a month. A comparable place nearby might rent for US$1,300, so you're ahead by about US$470 a month, and your cash invested is small. You pay for repairs and vacancy out of that margin too, so it's thinner than it looks.

Try your own numbers in the calculator. It shows the full property's figures, so subtract your own unit's rent to see what the deal looks like as a rental after you move out. That later number matters, because house hacking only works as a long-term investment if the property still makes sense once you're not living in it.

What can go wrong

You're the landlord, and you live next door. A late payment or a noise complaint gets handled in your own hallway. Some people love that. Others discover they don't want to be both a neighbor and the person who sends the late notice.

Vacancy hits you directly. When one of two units sits empty, your housing cost jumps. Keep several months of the full payment in reserve on top of the down payment.

The first year is a commitment. Occupancy rules mean you can't skip living there. If your job moves you at month six, you'll have a conflict with the loan terms.

Small multifamily is old housing. Many duplexes and fourplexes were built decades ago, so you'll want a thorough inspection and a repair budget. The cash needed to buy post covers what to save beyond the down payment.

Who it fits

House hacking fits someone who's buying a home to live in anyway, has some savings and can tolerate being a hands-on landlord. It doesn't work for investing from a distance. If you live in another city or another country, you can't meet the occupancy requirement, and the out-of-state route with a property manager is the one to look at.

Checking the deal

Even with a small down payment, the property has to work. Look at cash-on-cash return once you move out, at the cap rate, and at whether your market allows what you're planning. Check zoning and the local rental rules, and see what each state allows landlords to do.

We screen new listings against your numbers each night, including multifamily, so you only see the ones that clear your bar.