Resources > Rent vs. Own Decision

Which is right for you?

Housing costs are most transferee’s most significant financial expense. It is important that they make sensible decisions when it comes to their housing choices. To complicate matters, housing is much more than a financial decision. There is a huge emotional component that goes into their decision of where to live and may include a number of variables like; schooling, commuting, safety, reassignments, etc.

For decades there has been a stigma against renting which has obviously changed in recent years. Many people are now struggling with a framework to evaluate the rent vs. buy decision. There are many online calculators to help transferee’s now make this decision. The 5% rule has been in place for a long time and is still a helpful rule to help estimate and compare the cost of renting vs. buying. How it works:

The 5% Rule

The 5% rule compares the monthly cost of owning to rent. The 5% rule is an estimation of the three “unrecoverable” costs that homeowners face that renters do not. The monthly cost of renting a home is simple. The cost is equal to how much you pay in rent each month. The monthly costs of owning a home are more complicated and costs fall into three primary categories:

  1. Property Tax – is generally assumed to be 1% of the value of the home. This is the first part of the 5% rule.
  2. Maintenance Costs – are also assumed to be 1% of the value of the home. This is the second part of the 5% rule.
  3. Cost of Capital – is assumed to be 3% of the value of the home. This is the final part of the 5% rule.

The Buy or Breakeven Point

While the 5% rule is an oversimplification and does not provide the exact cost differences, it has been a helpful measure for many years. With today’s interest rates escalating to over 6%, conservative decision makers may want to increase the 5% rule to 8%. Again, this is an over- simplification as we are not taking into account some may important elements like: an individual’s tax bracket, home appreciate or depreciation, investment income, stock market fluctuations, the possibility for rental income, etc. That conveyed, here is how the 5% rule works in action.

  • Multiply the value of the home under consideration by 5%-8%
  • Divide by 12
  • The result is the breakeven point, where renting is financially equivalent to buying

This is best illustrated with an example. Let’s say the transferee is considering whether to buy a $500,000 house.

  • Multiplying the $500,000 by 5% = $25,000
  • Dividing that number by 12 = $2,083
  • $2,083 is the monthly breakeven point for owning that home so if you could rent an equivalent property for less than $2,083, you would be better off renting

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