Blog

Buying VS. Renting – How the 5% Rule Can Help You Decide

10 Things First-Time Homebuyers Should Consider Before Buying Property  Outside the City

Buying a home is often seen as a step forward in the game of life. But choosing the right time can be tricky. If you’re trying to figure out whether you should continue to rent or get your foot on the property ladder, it’s worth having a look at the 5% rule.

What Is the 5% Rule?

The 5% rule was coined by Canadian investment portfolio manager Ben Felix. It stems from the general consensus among potential homebuyers that if you can afford to make mortgage payments that are equal or less than what you’re paying in rent, then buying is a better alternative. However, the 5% rule puts the buying vs. renting dilemma in a different light by factoring in the unrecoverable costs that occur in both cases.

What are unrecoverable costs?

If you’re renting, they’re self-explanatory: your monthly rent is an unrecoverable cost. The money spent does provide you with a place to live, but it won’t help you own an asset as homeownership does. Also, the cases in which it can be used to improve your credit score are still rare, and they largely depend on whether your landlord will report those payments to a credit bureau.

In the case of homeownership, unrecoverable costs do not consist of mortgage payments. This is where the 5% rule comes in, highlighting three types of costs and their estimates, as follows:

  • Property tax, estimated at 1% of the home value;
  • Yearly maintenance costs, also estimated at 1% of the property value;
  • Cost of capital, or the mortgage interest rate, estimated at 3%.

When you add them up, these unrecoverable costs can add 5% of your home value to your yearly expenses.

Admittedly, maintenance can be considered a recoverable cost, as it can increase your home value through renovations and upgrades. However, renters looking to buy should factor in the cost of property tax and interest rates into their budget, as they can easily bulk up expenses by thousands of dollars each year.

How Can It Help You Decide?

The easiest way to look at the practical applications of the 5% rule is by using this simple formula: multiply the value of a property by 5%, then divide the number by 12. The result is a monthly break-even point, which could help you decide which is a better financial choice: buying or renting.

Let’s assume that you’re looking to buy a home in Canada, and the average price you’re looking at is around $680,000. Using the 5% rule, your break-even point is at $2,833 each month. This means that if you can find a rental that charges less than that, renting would make more sense. But if you’re paying more than $2,833 on rent, you might be better off buying a home instead.

One thing worth keeping in mind is that the yearly 1% set aside for maintenance is a bit ambitious. True, it is advisable to have that money set aside in case of emergency repairs. Yet, it’s unlikely that you will spend thousands of dollars on renovations and upgrades each year. So you can drop that 1% if you need to negotiate a bit of wiggle room in your budget.

Although the 5% rule can be seen as an oversimplification, it is helpful in giving you a wider perspective over the buying vs. renting conundrum. It is easy to base your decision just on finding a mortgage that’s cheaper than your current rent. The caveat is that this excludes not just hidden costs but also non-recoverable costs, which do not help you build equity.

 

Pilon Real Estate Group Featured Listings: Click here! 

We Keep You Covered When You Buy a Home With Our 12 Month Buyer Protection Plan!

Details at: www.HomeBuyerProtectionPlan.ca

Free Home Search With Proprietary MLS Access – New Listings – Faster Updates And More Accurate Data!

Find Homes Now: www.FindOttawaHomesForSale.com

Find Out How We Get Our Sellers More: Click here! 

RE/MAX Hallmark Pilon Group Realty
www.PilonGroup.com
Email: Info@PilonGroup.com
Direct: 613.909.8100

Related Posts

Compare

Enter your keyword