Resources > Rent vs. Own Decision
Which is right for you?
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:
- Property Tax – is generally assumed to be 1% of the value of the home. This is the first part of the 5% rule.
- Maintenance Costs – are also assumed to be 1% of the value of the home. This is the second part of the 5% rule.
- 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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