Joyce Crommett's Blog
For some, house hacking is the key to getting started in real estate; for others, it's just a smart way to build cash flow into an otherwise uncooperative rental market. Wondering how to get your foot in the door? Here's what you need to know.
What is House Hacking?
The term "house hacking" was coined by Bigger Pockets, but in general, the practice has been going on for as long as people have been owning and renting properties. House hacking refers to renting out a part of your primary residence. Generally, that means owning a duplex, triplex, or quadruplex, living in one unit, and renting out the rest. For some, it means renting out one or more rooms of a single-family residence. In an ideal scenario, house hackers can essentially live for free--allowing the rental income from the space they rent out to pay for the mortgage and maintenance of the entire property.
Why is House Hacking a Smart First Investment?
As with any investment, the viability of house hacking depends on the market in your area. But for many who want to get into real estate investing but haven't yet taken the plunge, it's a smart step.
- Owner-occupants enjoy the best financing terms. When you plan to use the property as your principal residence, you'll get lower down payments (as low as 0-5%, in the case of VA and FHA loans) and lower interest rates.
- House hacking serves as training for managing more tenants. Because you'll be living in close proximity to your tenants, it will be easier to keep an eye on your property and address repairs and other issues as they arise. It's a great way to earn a few notches in your landlord belt before purchasing more rental properties in the future.
- When you decide to move out, you can rent out the final unit (or the primary house) and enjoy the full benefits of positive cash flow thanks to your low-interest-rate home.
An Accessible Way to Start Small
Step one: talk to a lender. If you can get pre-approved for a single family residence, you can get pre-approved for a duplex (or larger).
Already own a home? Consider renting out an extra bedroom, or finishing the basement to rent out as an ADU. And even if you don't net massive positive cash flow at first, you'll massively offset your own cost of living, while gaining valuable experience as an investor and property manager.
If you are looking to get a new loan, especially for a mortgage, a bank or your lending institution will review and approve or decline your application based on the information you provide.
That said, there is certain information that prospective lenders consider carefully when they examine your application for a home loan. This article is all about that data and the steps you can take to support your loan application as well as realize your dream of owning a house.
Here is the critical information your lender looks out for when reviewing your loan application.
1. Your Credit Score
The number one place your lender will set their eyes on is your credit score no matter the channel you are coming from, either in person or online. This is a general rule of the thumb: if your credit score is high, you stand a better chance. Alternatively, if you have a low credit score, you will need to crack some hard nuts. So, you should give a critical look into your credit before taking the first step.
However, your credit score is just the first step. It could disqualify you immediately, but only a few banks will approve a new loan with a good credit score alone. If your bank disqualifies you based on your low credit score, do not panic as there are many other avenues to loan approval.
2. Your Payment History
If you pass step 1, now the real analysis begins. The first step after checking the credit score is to look at your complete credit history. Many banks have a system for underwriting loans using old school paper printouts. They would print your credit report for the loan file and would manually check it with a highlighter. They would select any late payments and mark them up to look for a pattern.
So, 90-day late payments are massive issues, although 30- or 60-day late payments may be pardonable. A pattern of late payments is enough to disqualify a loan application, even if you meet credit score requirements.
3. Your Ability to Repay Past Loans
When you pass steps 1 and 2, the banks will eventually shift their focus to your outstanding debt, income, and ability to repay the loan. By reviewing your complete credit report, they can determine if you have been responsible for past loans and possess the habits of making on-time payments.
There are many erroneous beliefs out there about how mortgage loans are approved. You need to show both that you have the income to support the loan and a history of responsible and on-time payments. Lacking one or the other can stop your mortgage application right in its tracks.
There is a reason why online lenders like Quicken Loans have amassed millions of customers over the past few years. Actually, there are a number of reasons. Here are a few just for starters.
Anyone with a phone or home internet connection can apply for a house loan online. Wherever you are in the country, you can ask for a house loan, and get it at a competitive rate. To be considered for a mortgage by a bank, you will need to be an account holder with them. Then you will need a bank official to walk you through the application process. Online lenders strive to make their application procedure easy to follow so you can do it yourself from start to finish with minimal guidance. Better Mortgage has been feted for its intuitive online process.
Getting approval for your mortgage application from conventional banks can prove to be like waiting for a miracle. Scrutiny on applications is tighter now more than ever in the wake of the recent financial crisis. You may have to wait for more than a month before you get a green light on your mortgage. Online lenders allow you to begin the process online if you’re interested in the product and are agreeable with the terms. Some, like Quicken Loans, promise to get your approval within a matter of minutes. Online mortgage providers will even allow you to complete the entire process online, giving a provision for you to upload all supporting documentation to their website securely.
You will find most, if not all, the information you need to decide on your loan on the lender’s website. Most of them have embedded a loan calculator on their webpages, which allows you to work out how much you will need to pay every month if you input the price of the house and your initial deposit. Even after you secure the mortgage, you can keep track of your repayment schedule without having to call or visit a branch.
A low credit score will quickly undo your application for a mortgage with JP Morgan Chase, Wells Fargo or any other traditional bank. After burning their fingers during the housing crisis, few of them are willing to take on the risk of FHA-backed house loans. This kind of loan was the low-hanging fruit for many first-time aspiring homeowners as well as those with lower-than-average credit ratings.
Browse through this independent review of online lenders if you intend to invest in a new pad soon.
With so much to think about these days, it is not surprising that some first-time home buyers make mistakes they later regret as they shop for a home for sale. Presented here are some of the most popular mistakes, along with tips to help you avoid a similar fate.
Looking for a home before getting a mortgage
Many first-time buyers make the mistake of seeing houses first before ever scheduling an appointment with a lending institution. In some big markets, housing inventory is still tight, and competition is so frightening. You might discover that you are eager to spend more to buy a property, or lose a property because you are not even pre-approved for a mortgage.
What is the solution to this?
Before you fall in love with that perfect dream house you have been looking at all this while, ensure you get a complete underwritten pre-approval letter. Being pre-approved sends the signal that you are a serious buyer whose credit and finances are ready to get a loan successfully.
Buying a house that your financial muscle cannot carry
It’s easy to fall in love with houses that might make you spend more, but over-stretching yourself can cause you regrets later. It could even put you at higher risk of losing your home if you fall on the unpleasant hammer of hard financial times.
The best way to overcome this issue is to concentrate on the monthly expenses you can genuinely afford instead of looking at the highest loan amount you qualify for. Just because you are eligible for a $250,000 loan, that doesn’t mean you can afford the monthly payments that come with it. Factor in your other financial obligations that do not show on a credit report along with additional home expenses like insurance and taxes when deciding on how much house you can afford.
Emptying your savings just to buy a house
One of the biggest mistakes you can make is spending every dime you have. When you invest all your cash, including your savings on the down payment and closing costs, you set yourself up for disappointment. It will do you no good.
Some people make the mistake of spending all they have saved to make the required 20% down payment, so they don’t have to pay for mortgage insurance. However, they are making a grave mistake as they are left with no savings at all.
Homebuyers who pay 20 percent or more down do not have to pay for mortgage insurance when getting a conventional mortgage. That often translates into significant savings on the monthly mortgage payment. However, it is not worth the risk of living on the edge.
Here comes the solution.Let your aim be to save three to six months of living expenses in an emergency fund. Paying mortgage insurance is not the best, but killing your emergency or retirement savings just to make a sizeable down payment is even more of risk.
Talk to your real estate agent about their mortgage and lender recommendations and get yourself pre-approved for a realistic mortgage before starting your home search.
It can feel like real estate has its own language. After all, there is a reason agents take courses and need to become licensed!
And for a first-time buyer, I understand that it can be overwhelming and very confusing to keep track of all of this new information on top choosing the home of your dreams and planning a move.
Which is why I’ve created this quick and dirty list of real estate terms every first time home buyer needs to know.
Let’s get started:
A kick-out clause gives the seller the option to continue showing a house after a buyer has made their offer but is slowing down the process with the sale of their own home. The seller can then “kick out” that offer if someone else puts in a more desirable, and readily available, one.
A title-search is simply a search to pull up relevant information to the title of a house. It helps to determine the history of the home and if there are existing regulations in place that affect the property.
Escrow is a neutral third party used to handle transactions throughout the buying/selling process. They hold all related documents and funds until the day of the sale.
Earnest money is usually held in an escrow account and represents your commitment to the sale of a house you have made an offer on. Typically, the amount out down is between 1-3% of the asking price. It is also called “good faith money”.
An appraisal determines a property’s market value. Only a licensed appraiser can pull a report of this information for you. This is the report a lender will use to determine whether or not to lend money to a borrower.
Closing costs are paid at the actual sale of the house. The “closing” is when the title is transferred from the seller over to the buyer. The cost covers all of the fees that were incurred throughout the buying and selling process. A few examples of these fees are the home inspection, appraisal, and escrow.
A comparative market analysis or CMA is a report pulled from a database your real estate agent has access to. This is then used to determine the offering and asking price of homes.
A contingency is when in order to move forward with a sale there are specific requirements the buyer must complete first. Common contingencies are: waiting on an inspection, pre-approval or signing.
Disclosures are required by law. But what are they? A disclosure means a seller has to inform potential buyers of and problems that would affect the value of the property.
Due diligence is doing the work of fully understanding the property you are interested in before buying it. This includes obtaining insurance, reviewing all documents carefully and walking the property.
During a home inspection appliances, plumbing and electrical work are tested. The heating and cooling system are also inspected. This doesn’t affect the monetary value of your home. This is a way for you to determine what state a home is in and if it is worth the financial investment to you.