House Hacking: A Simple Guide To Living For Free

Rent and mortgages make up a large portion of the average person’s monthly expenses. Odds are, one of those two makes up a large percentage of your monthly expenses too. That has certainly been the case for me. Then one day, I came across the idea of house hacking. At first, I didn’t think it was possible. The more I researched it the more I realized that it wasn’t only possible, it was replicable. Thousands of people have done it on their quest for financial independence. So what is it, you may ask? House Hacking.

House hacking is the idea of buying either multifamily housing or a single-family home (a.k.a a regular house) and having other people pay the mortgage, taxes, and bills for you.

But why would someone else pay your mortgage? Because you’re giving them a place to live and charging rent in return. You then take that rent and apply use it to pay your bills, leaving you to live for free.

How can you do this?

The key to house hacking is owner occupancy. If you live there and it’s less than 5 units, you’re eligible for an FHA loan, which minimizes your down payment, greatly reducing real estate’s barrier of entry.

Let’s take a look at an example.

Example

You buy a duplex that costs $200,000 and requires a $7,000 down payment, resulting in a $193,000 loan and $1,100 monthly payment. That means you need to make $1,100 each month to pay the mortgage.

The money is made on the second unit. Since there are two bedrooms, you rent the unit out for $1,200/month. As a result, your mortgage is paid by your tenants, and you have $100 a month to put towards utilities. As a result you’re essentially living for free.

If you decided to move out of the apartment, you could charge $700 a month for your unit, leaving you to come out $700 ahead every month. In that case, you could use the money you’re making to help pay for your new mortgage or apartment.

Alternatively, you could repeat this process a few times, using the savings and profits to grow your real estate holdings and investments. Many real estate investors that are making $10,000+ a month started their journey through house hacking.

Regardless, having someone else pay your housing costs significantly reduces the cost of financial independence and can help push it forward several years.

While this approach may not be for everyone, it’s a useful method and worthwhile to understand.

The idea of this post isn’t to make you an expert, but to let you know that it’s possible.

If you want to learn more, check out this post on Bigger Pockets. It’s where I first discovered this idea and it goes much more in depth. They also do a series of podcasts on the idea, for those that think this may be for them.

Tiny Houses: An Economic Analysis

Many people are unable to see themselves living in a tiny house because of “the bigger is better” American mentality. Nonetheless, tiny houses are growing in popularity nationwide due to a variety of benefits. For example, owning a tiny house, instead of the traditional 4 bed 3 bath family house, could allow for financial independence (or retirement) up to 10 or 20 years earlier.

Before continuing, it’s important to note that the point of this analysis is not to prompt anyone to live in a tiny house. It’s merely constructed to show that there are alternative ways to live, many of which are unknown by mainstream society. For people that highly value financial independence or a small environmental footprint, a tiny house provides an effective solution. On the other hand, someone that has a family of 10 may find living in a tiny house impossible. It’s not for everyone, but it provides an interesting perspective on avoiding traditional housing and the mortgage that accompanies it.

The finances in the rest of this article are based on these example prices. Actual prices fluctuate depending on your location and an individual analysis needs to be completed to see costs that are applicable to you. That being said, these prices will provide a solid approximation.

  • Home Price: ~$200,000
  • Tiny House Price: ~$60,000
  • DIY Tiny House Price: ~$20,000 (varies widely depending on skill)

A regular home costs 3 times as much as a tiny house and 10 times as much as a DIY tiny house. These large gaps in price are significantly inflated when mortgage loans are incorporated. When it comes to personal finance, this is an enormous amount of money.

Consider the following scenarios.

Traditional House:

Imaginary Dave chose to buy a $200,000 home. He placed 20%, about $40,000, down. Then he took out a standard 30-year loan of $160,000 with an interest rate of 4.28%. Dave paid back the $160,000 loan with a monthly payment of $1,163. When all was said and done he paid back $120,000 in interest, $320,000 total, for a $200,000 house. It only took him 30 years.

Tiny House:

Consider the tiny house, which costs $60,000. In this instance, Imaginary Dave also put $40,000 down on the home. As a result, he needed to take out a $20,000 loan with the same 4.28% interest rate. He decided to make monthly payments of $1,148, which are similar to payments made on the traditional house above. In this instance, Dave paid back the $20,000 loan with a total of $904 of interest. The grand total of the tiny house purchase comes out to $60,904. It took him only 2 years.

At this point in time, Dave decides to take $1,163 (the loan payment from the traditional house) and invest it each month. He chooses a traditional index fund that averages an 8% return on investment (ROI) each year. He continues investing the same amount for the next 28 years, which is the time he would have spent paying the traditional loan. At the end of 28 years, Dave has amassed $1,450,000 in investments, because he chose a more affordable home and invested the difference.

NOTE: It can be difficult to find a conventional mortgage for a tiny house. It may have a slightly higher interest rate or you may have to look at a private loan. Saving for another year makes it possible to avoid the loan altogether.

DIY Tiny House:

Building a tiny house is no small challenge. They have been done in varying price ranges. Some have been built for as little as $4,000 in only 6 weeks. However, this is likely unrealistic for most people. Assuming that the house can be built in 1 year if Imaginary Dave worked on evenings and weekends, it could be done for ~$20,000 with an extra ~$6,000 for rent while the house is being build.

Starting with $40,000 as done in both cases above, Imaginary Dave can buy the materials and pay those that are helping him build the house outright. He also has money for rent over the course of the year. He spent $26,000 for the entire project.
It took him a year, but he was never in debt. Dave invested the $14,000 that was left over as a lump sum. Additionally, he decided to invest the equivalent of the first home’s mortgage, $1,163, each month. Being a savvy investor, Dave chose to invest the money in an index fund and earned 8% annual returns. At the end of 30 years, he has amassed a small fortune of $1,886,388.

Alternatively, Imaginary Dave could follow the same plan as above, except instead of investing for 30 years, he could decide he’s ready to settle down and have a family. Following the investment strategy above, Imaginary Dave built a nest egg of $211,000 by the end of year 9. He used $200,000 to buy the home and $11,000 to furnish it. Finally, he rented out his tiny house for $500 a month instead of selling it. Now he has $500 in passive monthly income and he owns the regular house without debt at the end of year 10, allowing him to continue investing in his local community while turning a profit at the same time.

Implications

It’s not a surprise that many people in the US are struggling to make ends meet. Many people live paycheck to paycheck and plan to live on social security payments once they retire, unaware of the alternative options.

The tiny house example above shows one such option and it only covered the simple solution of investing the money that would have gone towards a mortgage. Looking a bit deeper at the idea, one would find that tiny houses have lower property taxes, lower utility bills, less underutilized space, and significantly more flexibility.

An important thing to remember is that these financial benefits compound. The $1.8 million above was made from investing the mortgage in a standard index fund but imagine the results if other strategies were utilized. For example, someone making $50,000 annually that takes advantage of their employers 401k match on 5% of their paycheck would see that $1.8 million bump up to just under $2.2 million. That small choice equates to an extra $400,000 at the end of 30 years. If utilities and tax savings are added to the equation the return is even larger. Consider the potential results if Imaginary Dave had invested an extra 10% of his income as is commonly recommended in popular financial literature; remember all of the results thus far come solely from reallocating a mortgage and not from investing extra portions of his paycheck. Had Dave taken that course of action, he would have ended up with $2.8 million in his account. If he started this journey at the age of 25, he could fund several retirements by the age of 55, a distant 12 years early than the current retirement age.

To put this into perspective, if someone spends $20,000 on building a tiny house, invests the equivalent of a traditional mortgage payment, invests an additional 10% of their income, and takes advantage of a 5% 401k match, then they could reach financial independence, with $2,100 to spend each month, at age 37. Of course there are a number of options for further financial prosperity at this point. Imaginary Dave can work on his own startup, start teaching classes at his local CrossFit box, volunteer at his church, plant his own garden, or just relax in retirement bliss. If he truly wants to become rich, he can continue working his job.

Most other economic benefits of tiny house living are significantly less concrete, mostly consisting of the benefits of living in a smaller space. Most people fall into the trap of needing to fill empty space, even if there is no good reason to. As a result, money is wasted on items that are never used. Tiny houses cause the owner to consider items before they are purchased, because space is extremely limited. Typically, that frugality will carry over into other areas, allowing for continued wealth building.

Drawbacks

While the positives vastly out way the negatives, there is one primary drawback to owning a tiny house instead of a regular home. Their low cost makes them inefficient for asset protection purposes. Many places provide homestead exemptions in the case of bankruptcy. If someone owns an enormous, $3,000,000 house in Texas or Florida, they know their equity in the house is safe and they’ve essentially protected $3 million due to their states’ generous homestead exemptions. Tiny houses, on the other hand, won’t amount to as much. As a result, a doctor or dentist that may face a lawsuit from an angry client one day may be better off purchasing a regular homestead, because it will better shield their money from prying hands.

A secondary drawback comes when finding loans for a tiny house. Some banks won’t consider a tiny house to have enough collateral. In which case, it can be difficult to obtain the loan as they will say no or ask for an inflated interest rate. This can be difficult to navigate, but it’s definitely possible. Remember, a high interest rate (10ish %) on significantly less money over a much shorter time will still result in less interest paid to the bank.

The third possible drawback could be the zoning laws of particular states and cities. Some places require a minimum dwelling size, which tiny houses can struggle to meet. In these instances, it may not be as beneficial to live in a tiny house. For example, it may be undesirable to add 45 minutes onto a daily commute in order to meet zoning requirements.

Conclusion

Tiny living provides some pretty extraordinary positives with relatively few drawbacks. For those that value financial independence, it’s an incredibly powerful method to reach that goal several years earlier. If the mortgage payment is redirected into investments, it’s possible for one to retire in their 30’s rather than in their 60’s. Something to keep in mind is that the example above fixed Imaginary Dave’s salary at $50,000 for 30 years. In many cases, salary increases with experience, and it’s not uncommon for someone to double or triple their earning potential in a 10 year period. In those cases, it may be possible for someone to retire in their late 20’s.

There are several other possible benefits outside the realm of financial independence. Consider some of the things that could be done with only the $120,000 saved on loan interest, a mere fraction of the total benefit.

You could:

Hopefully, if you’re still reading this, you’ve realized that there are an endless number of possibilities if we escape conventional thinking. The same principles applied here can be applied in all aspects of life, and the results would be astounding if people took the time to see all of the possibilities.


Notes from the Author

  • I’ve used the word retirement throughout this post. Try to think of this more as financial independence.
  • When considering possible outcomes, remember to consider chain effects. Moving into a tiny house on it’s own does very little to improve wealth, but investing that money wisely gives it an enormous effect. Similar chain reactions are available everywhere and they make living an amazing life extremely possible. However, this is only the case if you’re aware of the possibilities.
  • Dave’s $50,000 annual income is very realistic, meaning the feasibility of this approach to financial independence is equally realistic. This disproves the case that only millionaire business owners can be financial independent.
  • Interestingly enough, the word mortgage means “death pledge” in french. This is because it’s designed to profit off someone working their entire life to afford a large house.