Can 'house hacking' help Gen Z afford homeownership?

More than half of buyers in younger generations are interested in seeing if they can use "house hacking" — or rental income — as a way to afford homes, Zillow found in a recent survey. 

And some loan officers, like John Birke of Movement Mortgage, have developed marketing aimed at tapping into this interest on TikTok, a social media channel the industry has been experimenting with as a way to reach younger generations.

"I've done several videos about house hacking. I think it's going to become more and more popular in the future," Birke said. "Both Gen Z and millennials are frustrated that they've been essentially shut out of the housing market with few options for buying a home."

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In one such video run next to — or "stitched" with — Daniel Mac's interview with "Shark Tank" judge Barbara Corcoran, Birke nods at her answer to a question about how "an average 20-year-old" can build wealth and suggests in related text that those interested contact him for loan information.

"Buy the cheapest multifamily you can in an area that has good rentals. Live in one half of it and the tenant will pay your expenses," Corcoran says in that interview.

But is using rental income to make financed home purchases more affordable a realistic option for younger, first-time buyers to the degree that the strategy could create strong mortgage leads?

In some ways the time is ripe for those who establish a history of paying for housing to buy and live in a property with rental income, but the math has to work and there are risks, industry professionals say.

The lay of the land
The strategy of buying a property to partially rent out is getting renewed attention in part because it's well aligned with some trends in the current market.

"Housing is very costly. People are definitely more open to sharing space," Danny Gardner, Freddie Mac's senior vice president of mission and community engagement, said.

Some seeking to increase affordability by sharing space opt for multigenerational living spaces, but for others, it leads to an owner-occupied rental strategy.

"We mostly suggest to first-time homebuyers — young professionals in their 20s and early 30s with a solid salary and a good job — instead of purchasing a typical single-family home, why not get into a duplex where you can live on one side and rent out the other," Filippo Incorvaia, founder/broker, FI Real Estate, said.

When asked whether the strategy is a good hack for housing, he said it could be considered one in the sense that rental income can effectively supplement qualifying income and ongoing housing costs for some buyers.

"Anybody could kind of feel like it's cutting corners or hacking," Incorvaia said. "Sometimes, we try to do this because we know that [Federal Housing Administration] has really good programs for single-family homes, or even residential properties under four units."

But financing a purchase based on rental income may not always be easy to do.

While Federal Housing Administration-insured loans can work for some first-time buyers, inventory within FHA loan limits may be scarce in some markets and competition from cash buyers can be fierce, said Incorvaia, whose company is located in the Miami area.

"Our price point is much higher than the rest of the country," Incorvaia said. "But in certain areas it's do-able. It depends on the buyer's requirements in terms of where they want to live and how close it is to their place of work."

While Corcoran suggested that a duplex is a good property type to start with, Dustin Martin, mortgage underwriting training manager at Embrace Home Loans, said whether or not it is depends on the composition of local inventory and where the buyer wants to live.

"I think it really depends on the area," Martin said, noting that when he was underwriting in Massachusetts he worked in a region where there were a lot of three- to four-family properties.

Unit options
Loan applicants might need more units to bring in enough income to qualify for financing in some cases. But criteria for both loans and down payment assistance may differ based on the number of units and type of program, so applicants should consider these factors as well.

The amount of rent a tenant could bring in based on an assessment of market rates generally plays into how much credit a lender wants to give for it in underwriting.

The amount might vary, particularly if the borrower is applying for portfolio loans with criteria set by individual banks, Incorvaia said. It's also worth noting that depositories were facing certain proposed regulatory requirements at deadline that could make affordable financing for first-time buyers with lower down payments less accessible. 

This divisive capital plan proposal under review could lead banks with $100 billion or more in assets to further distance themselves from the housing finance business because it adds higher risk weightings for portfolio products with elevated loan-to-value ratios. Loan applicants may want to reduce potential rental income by at least 25% when trying to calculate whether they have enough to qualify. Underwriters generally adjust the amount to account for vacancies between tenants and other costs, Martin said.                             If the math doesn't work out for a multiplex or buyers want to minimize landlord responsibilities, it might be worth looking into whether an accessory dwelling unit or a paying roommate on a single-family property.

Freddie Mac defines an ADU as a space with a separate entrance, kitchen and bathroom but which "may share utilities and common walls with the primary dwelling unit." That means a smaller property than a traditional duplex may accommodate it, depending on local rules.

The traditional accessory dwelling unit is a "mother-in-law suite," but one may be rented out to people outside the family. Gardner cites the 1970s television show "Happy Days" and the garage apartment the Cunningham family rented to a character called Fonzie as an example.

While the ADU isn't a new concept, some jurisdictions such as Charlotte, North Carolina, have been changing local policies to make them more accessible.

"Rezoning has made it possible to build multifamily properties and ADUs in neighborhoods where they hadn't been before," Birke said, noting that previous to the change, housing with income-producing units was limited.

Also some secondary market underwriting has been expanding and opening up options in this area, Gardner noted, referencing adjustments Freddie Mac — which is one of two government-sponsored enterprises that buy, securitize and back many U.S. mortgages — made in June of 2022.

Both Freddie and its competitor, Fannie Mae, have made some changes that have made the loans more accessible and somewhat more competitive with the FHA's low down-payment products.

"Conventional loans required at least 15% down for multifamily units, which was impossible for most first-time buyers. But Fannie Mae just changed their rules to allow a 5% down payment on 2 to 4 unit properties," Birke said.

While financing for multiplexes is becoming more accessible in some instances, if they're out of reach, another alternative for a first-time homebuyer is to ask someone they've rented space with in the past if they'd like to be a tenant and share a single-family home. 

"If they had a roommate that they've lived with and can show payment history, then we might be able to count it toward additional income to help them qualify for a mortgage," Martin said.

Freddie Mac has flagged "a renter with two long-term roommates wants to make the jump to homeownership and will bring her boarders with her" as a good prospect for the low down-payment loans it offers through its Home Possible program to first-time buyers.

"We do permit a person who is not the spouse of the property owner to have their rental income used for qualification purposes, as long as it can be demonstrated that that individual has resided with the borrower for at least 12 months, and it doesn't have to be in the residence," Gardner said.

In order to finance the purchase of any kind of live-in rental property, loan applicants should be able to show that they have been paying tenants for at least a year. Ideally that history would be with a landlord from outside the family, but in some circumstances renting from relatives will suffice.

"Some people, after a certain age, if they're still living at home, their parents do charge them rent. If we could capture that with canceled checks, that might be a possibility," Martin said. "It just becomes a little more difficult because we're getting information from someone who has a bias toward the borrower to help them. So we have to be extra careful to document it appropriately."

Learning to be a landlord                                                                                                                                                                     What makes or breaks a first-time buyer strategy that relies on rental income is ultimately whether the purchaser can go from being a tenant to managing one.

As the pandemic illustrated, property ownership costs and responsibilities can be particularly complex for landlords. A homeowner may need to manage an eviction ban or public assistance programs because it's subject to the rules of various entities governing the property or loan.

First-time homebuyers from Gen Z would do well to take a property management class for this reason. Some municipalities mandate landlord education and there are nonprofits in others that can provide it, Gardner said.

"Landlord education is available in many cases, it can also be required, especially if you're using certain sources of funding to become a landlord," he added, citing a federal downpayment assistance program that allows purchases of one- to four-family properties as one example.

"I would definitely encourage anybody wanting to wade into these waters to seek that out," Gardner concluded.