What Is the 5% Rule in Renting vs. Buying a Home?

TL;DR

The 5% rule helps assess the financial decision between renting and buying a home by estimating total unrecoverable costs. To apply it, multiply the home's value by 5% and divide by 12; if rent is lower than this amount, renting is financially wiser. Key costs include property taxes, maintenance, and opportunity costs of capital.

Transcript

• I have talked about the decision around renting versus buying a home before. But in this video I wanted to take a bit of a different angle. The common perception is that if you can purchase a home with a mortgage payment that is equal to or less than what you would otherwise pay in rent then buying is a good decision. This way of thinking about t... Read More

Key Insights

• 👪 Comparing mortgage payment to rent is not an accurate way to assess the rent vs. buy decision because it doesn't consider the total unrecoverable costs of owning.
• 🙃 The 5% rule provides a simple calculation to estimate the total unrecoverable costs of owning a home.
• 🙁 Factors like tax rates and portfolio asset mix can affect the 5% rule and potentially reduce the total unrecoverable cost of owning.
• 🇨🇷 The cost of equity capital, including the opportunity cost of not investing in stocks, is an important factor to consider in the rent vs. buy decision.
• 📏 The 5% rule can be a useful tool for aggressive investors and those who haven't maxed out their registered accounts.
• 😘 For more conservative investors and taxable investors, a lower percentage may be used in the 5% rule.

Questions & Answers

Q: Why is comparing mortgage payment to rent not a meaningful comparison?

Comparing mortgage payment to rent doesn't consider additional costs of owning, such as property taxes, maintenance costs, and the cost of capital, which are unrecoverable costs for homeowners.

Q: What is the 5% rule used for?

The 5% rule estimates the total unrecoverable costs of owning a home by multiplying the home value by 5% and dividing by 12. If the rent is lower than this estimate, renting is financially more sensible.

Q: What factors can affect the 5% rule?

Tax rates and portfolio asset mix can affect the 5% rule. For example, if investments are taxed, the after-tax return might be lower, reducing the cost of equity capital and potentially decreasing the total unrecoverable cost of owning.

Q: How does the 5% rule help in the rent vs. buy decision?

The 5% rule provides a simplified way to compare the financial aspects of renting and owning a home. If the rent is less than the estimated total unrecoverable costs of owning, it may be more financially sensible to rent.

Summary & Key Takeaways

• Comparing mortgage payment to rent is not a meaningful comparison because it doesn't account for total unrecoverable costs of owning a home, such as property taxes, maintenance costs, and the cost of capital.

• The 5% rule suggests estimating the total unrecoverable costs of owning a home by multiplying the home value by 5% and dividing by 12. If the rent is lower than this estimate, renting is financially more sensible.

• Factors like tax rates and portfolio asset mix can affect the 5% rule, potentially reducing the total unrecoverable cost of owning a home.