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Eager to become a homeowner without having to worry about affording your monthly mortgage payments? Here’s a housing hack that could pay serious dividends: Purchase a multifamily property, move into one of the units, and rent out the remaining units.
Doing so can help cover your mortgage by generating a steady income stream from paying tenants. But know what you’re signing up for prior to taking the landlord plunge, as this strategy carries risks and responsibilities.
The pluses of being a landlord
There’s a proven path to homeownership and savvy investing: Simply become a live-in landlord. This provides both a primary residence where you can reside as well as adjacent owned property you can lease out to tenants.
Those rents you collect can cover some or all of your mortgage payments and housing expenses, enabling you to save significant dollars over the long run.
Even if you’ve never owned a residence before, you may qualify for a mortgage that can fund the purchase of a rental property. Or, you can sell your existing home and use the proceeds to help pay for the purchase of a rental property you also call home.
The easiest way to house hack as a first-time landlord is to purchase a duplex, triplex, or fourplex where you reside in one of the units and lease out the others. Or, you could convert a portion of a single-family detached home into a rental unit—such as the attic, basement, or other interior space, or an accessory dwelling unit built in the yard.
“With mortgage rates higher this past couple of years than ever before, some potential home buyers have had to get creative to be able to afford the investment,” says Marty Zankich, director and owner of Chamberlin Real Estate School. “One of the main perks of buying a multifamily home that you live in and rent out is the money you get from rent can be used to pay your mortgage – thereby reducing the amount of income you need to qualify for the mortgage loan. Also, when lenders see you are purchasing an income property, they may approve a higher borrowing amount.”
To demonstrate the possible return on this investment, imagine you purchase a triplex for $300,000. You reside in one unit and rent out the other two for $2,400 combined per month.
Meanwhile, your mortgage, taxes, and homeowners insurance add up to $1,800 per month. That means your annual income minus expenses should equate to a surplus of around $600 per month, which will cover your personal housing expenses and provide a tidy profit, too.
“Or, assume you buy a $500,000 fourplex that requires a 25% down payment of $125,000,” says Andrew Lokenauth, a personal finance expert. “You can generate combined rental income on the other three units of $3,000 per month, which exceeds your $2,300 per month mortgage. After expenses, you can likely expect to earn a $10,000 annual profit.”
Real estate agent Mike Wall points out other advantages to this approach.
“You may benefit from long-term property value appreciation, which can result in significant home equity accrued,” he notes. “You may also qualify for tax deductions on mortgage interest, property taxes, and maintenance expenses paid. Plus, living on-site may reduce your own living expenses.”
Buying a duplex, triplex, or fourplex can often be more beneficial than purchasing a single-family home you plan to landlord within and rent out, “especially if the rental market is strong in your area,” explains Lokenauth.
Drawbacks to consider
But careful thought is required here, as landlording isn’t so easy, particularly for first-time buyers who’ve never owned or rented out a home before.
“You may end up selecting tenants who don’t pay on time, don’t take care of their unit and the building, or cause noise or other types of problems that bother both you and other tenants,” warns Suzanne Hollander, an attorney and broker who teaches real estate law at Florida International University in Miami.
“Another con may be the need to evict a tenant. Most states require due process before evicting a tenant for non-payment of rent or for defaulting on other lease requirements. Depending on the state law where your property is located, due process may allow the tenant to reside in your building for months, even when they are in default of payment or rent or other lease provisions. Remember that if it takes time to evict the tenant, you will lose the income from that tenant during the period the due process takes, and you will still have to cover the costs of property tax, insurance, and repairs.”
Speaking of, the multifamily property or single-family home you purchase will require regular upkeep and repairs. If something malfunctions in a tenant’s unit—such as the stove breaking or the heat not working—you or someone you hire will have to fix it. That’s going to require salting away extra funds for maintenance and emergencies.
Another drawback? You’ll be in high demand if things go wrong.
“Tenants may not respect your personal time. For example, if a tenant is having an issue that needs to be resolved, they may knock on your door and expect an immediate response,” Realtor Gabriella Siciliano cautions.
What’s more, living near renters could compromise your personal privacy.
“And rental income and property values can fluctuate with the market,” Wall adds.
Put another way, this is an investment that can quickly decrease in value.
» MORE: See today’s refinance rates
Financing challenges involved
You also need to qualify for a mortgage loan, which can be more difficult if you are a first-time buyer. That means you’ll need:
- A good credit score, typically at least 620. A higher score may get you a lower interest rate and better terms.
- Debt-to-income ratio. This is a representation of your monthly gross income devoted to repaying debt. Your DTI will likely need to be between 36% and 45% to be eligible for a mortgage loan. Your lender may allow you to designate 75% of their respective monthly rental income as extra qualifying income, which can decrease your DTI.
- Sufficient down payment. Depending on the type of mortgage loan you choose, you may be required to put down 20% or more. But some loans require as low as 3% (more on this next).
- Financial reserves. Your lender will want to see proof of ample savings in the bank, which demonstrates that you can withstand unexpected expenses like repairs and a vacant unit that generates no rent. Try to salt away three to six months of expected housing expenses.
Borrowers pursuing the live-in landlord house hack this article promotes can opt for a conventional loan backed by Fannie Mae or Freddie Mac, or a government-backed FHA home loan. With a Fannie Mae HomeReady loan or a Freddie Mac Home Possible loan, you can purchase a single-family home with a 3% down payment and two-to-four-unit homes with a 5% down payment.
With an FHA loan, you can qualify for a one- to four-unit rental property and only be required to put as little as 3.5 percent down. With any of these loans, you must commit to reside in the property for a minimum of one year.
After that time, they have the option to relocate while retaining ownership of the property for rental purposes, without being the primary occupant, or you can stay put and rent out the other units or a portion of your single-family home.
Good candidates for becoming a landlord
Per Wall, the best prospects for live-in landlording are those “with patience, good people skills, and a knack for problem-solving. You should also be a financially stable individual who can handle unexpected expenses, as well.”
Siciliano echoes those thoughts, adding that it helps tremendously if you can perform property management, maintenance, and repair tasks yourself versus hiring outsiders.
“This is a great option for buyers who are looking for a good return on their investment,” she says. “But those who prefer to live alone or assume little responsibility should probably look at alternative options. Being a landlord who lives in the property is a massive responsibility that takes time and passion,” she says.
What to consider carefully before choosing this route
Hollander points out that it’s tricky in the current real estate market to find a property that will enable you to consistently make money and not lose money.
“This is a challenge because interest rates are high at the same time that purchase prices are high. Also, there is a strong demand for multifamily properties because they are seen as less risky than purchasing office or retail properties, as the thought is everyone needs a place to live,” she adds.
You also need to carefully consider who you will contact if you need help, including a roofer, plumber, electrician, snow plow service, licensed contractor, or general handyman.
“You need to build a trusted team of these professionals who will help you maintain the property and who will offer to come to the property and do the job in a timely manner,” continues Hollander.
Prepare to crunch the numbers and do honest forecasting.
“Ensure you can afford the property, even with rental vacancies,” recommends Wall. “Understand the demand and average rents in your area. Familiarize yourself with landlord-tenant laws and housing regulations, too.”
Most importantly, ponder if being a landlord will fit your personal and professional lifestyle and provide satisfaction. You may ultimately determine that it’s not worth the stress, financial risks, and effort that come with the job.