The 5% Rule Revisited (2024)

A rational approach to the rent vs. buy decision in an irrational world

The 5% Rule Revisited (3)

The decision of whether to buy or rent a home has become one of the most debated topics in personal finance. While some believe that owning an asset is always better than paying rent, others look at the cost of ownership as too high to make it worthwhile.

Luckily, Canadian portfolio manager and YouTuber Ben Felix developed a rational approach to answering the rent vs. buy decision that he calls the 5% rule.

Here is how the 5% rule works. Multiply the value of the home by 5%, then divide that number by 12 to get your breakeven point. If the monthly rent on a comparable home is below the breakeven point, it makes financial sense to rent. If the monthly rent is higher than the breakeven point, it makes financial sense to buy.

In this article, I’ll review the 5% rule and expand on the discussion by focusing on some of the crucial questions that the 5% rule does not address and other critical questions you should ask before deciding whether to rent or buy.

The 5% rule

The idea behind the 5% rule is to compare what Ben Felix calls the “unrecoverable costs” of renting and buying a home.

The monthly cost of renting a home is simple; it is equal to how much you pay in rent.

The monthly costs of owning a home are more complicated. Homeownership costs generally fall into three categories.

  1. Property tax
  2. Maintenance costs
  3. Cost of capital

As part of the 5% rule, Felix assumed the annual cost of taxes and maintenance to be 1% of the value of the home. For a $500,000 home, that would work out to be $5,000 for both taxes and maintenance for a total annual cost of $10,000.

You might be wondering what “the cost of capital” of buying a house means?

This is where things get a bit technical, but essentially it refers to the cost of a mortgage + the opportunity cost of using your downpayment to buy a house rather than invest in the stock market.

It’s best to illustrate with an example.

  • Let’s say you buy a $500,000 house with a $100,000 down payment.
  • You get a $400,000 mortgage at the rate of 3%.
  • Felix then compared the historical return in the stock market compared to real estate and found that, on average, the stock market has outperformed real estate by 3% per year.
  • That means your $100,000 downpayment has a 3% per year opportunity cost because you put it in real estate rather than the stock market.
  • So the total cost of capital (debt+equity) is 3%.

That’s where we get to 5%

  • 1% for property tax.
  • 1% for maintenance costs.
  • 3% for the cost of capital.

If you want to get into the details on the numbers behind the 5% rule, check out this article.

Here is how the 5% rule works in action

  • Multiply the value of your home by 5%.
  • Divide by 12.
  • The result is the breakeven point, where renting is financially equivalent to buying.

Returning to our example where you are considering whether to buy a $500,000 house. Here is how to use the 5% rule to find the breakeven point on the rent vs. buy issue.

  • Multiply the value of the home by 5% = $25,000
  • Dividing that number by 12 = $2,083.
  • $2,083 is the monthly breakeven point for owning that home

If you could rent an equivalent home for less than $2,083, you are better off renting.

If it would cost you more than $2,083 to rent a comparable home, you are better off buying.

The 5% rule is a rational framework to help think about the rent vs. buy decision. Having said that, it is far from perfect and does not address a lot of critical questions surrounding the decision of whether to buy a home.

Let’s address some of those issues not addressed by the 5% rule.

You were so preoccupied with whether or not you should; you didn’t stop to think if you could

The 5% rule answers whether it is rational to rent or buy a comparable home.

What it does not do and does not intend to do is answer an even more important question; are you in a financial position to buy a home?

One of the most common questions I get from readers when I write about real estate is how much of your income should you spend on housing costs?

There is no magic number, but the most common advice from financial experts is to spend no more than 30% of your gross income on housing costs.

How to determine if you can afford to buy a house in 5 steps

If you are wondering if you can afford to own a particular house, you can follow these five simple steps.

  • Step 1: Google “mortgage calculator” and determine the estimated monthly mortgage for a house you are looking for. Multiply the monthly mortgage payment by 12.
  • Step 2: Add 1% of the purchase price for property taxes.
  • Step 3: Add 1% of the purchase price for maintenance costs.
  • Step 4: Add an estimate for the annual utility costs.
  • Step 5: Add the total from steps 1–4 and divide that number by your gross (pre-tax) annual income.

The result from step 5 will tell you how much of your gross income you can expect to spend on housing costs each year if you buy the property. If it is above 30%, then you likely cannot afford to live in that house.

People are human, and humans are not rational

My educational background is in economics, so naturally, I love the 5% rule because it explains how a perfectly rational person would make a decision.

Here is the problem with the 5% rule and most economic models; people are not rational.

That is where the “cost of equity” assumption falls on its face. If you had $100,000 saved for a down payment on a $500,000 house and you decided to rent instead of buy, the 5% rule assumes you would invest that $100,000 in the stock market.

It’s what the perfectly rational person would do.

Sadly, the perfectly rational person does not exist. In reality, most people would not invest any of that $100,000 in the stock market, let alone the whole thing.

Perhaps the greatest benefit of owning a home is that it forces people to save.

  • On average people do a poor job of finding money to invest in the stock market.
  • Overwhelmingly, people do a fantastic job of making their mortgage payments.

When considering whether to rent or buy, It’s important to be honest with yourself. The less likely you would be to invest extra money as a renter, the more the math favors owning over buying.

I wish more people were comfortable investing (it is one of the goals of this publication), but the data is clear that people won’t (or can’t) save enough money unless they are forced to do so.

That is why pension plans and mortgage payments are an easy way for people to boost their savings rate; when saving is made mandatory, people will save.

Closing costs of buying a home

When you buy a home, there are a lot of fees and taxes you will have to pay.

All-in closing costs can range from 2%-7% of the purchase price of a property.

These closing costs are not explicitly accounted for in the 5% rule.

This would add to the opportunity cost of owning a home for the rational person who would invest the money otherwise used for closing costs. However, as we have already discussed, most people are not rational and would probably only invest a small percentage (if any) of the savings on closing costs if they chose to rent.

The mortgage interest deduction

One of the smartest questions when I first wrote about the 5% rule was how the mortgage interest deduction factored into the equation?

The answer is that it does not.

Like me, Ben Felix, who came up with the 5% rule, is Canadian. Sadly, we Canadians do not have a similar program to the Mortgage Interest Deduction in the U.S, where homeowners can potentially deduct interest on $750,000 to $1 million of mortgage debt.

If you live in the U.S and you can deduct some or all of the interest you pay on your mortgage from your taxes, that pushes the math to favor owning over renting.

The higher your marginal tax rate, the more attractive buying looks compared to renting for those in the U.S.

House hacking

The 5% rule assumes that if you buy a home, you and your family are the only people that will live in that home.

But what if that isn’t the case?

The term house hacking refers to situations where someone finds a way to generate rental income from their primary residence. This effectively lowers the cost of housing for the homeowner.

Common examples of house hacks include;

  • Renting your house on Airbnb when you are out of town.
  • Renting out a room in your house.
  • Buying a multi-family property and living in one unit while renting out the others.
  • Turning a basem*nt into a (legal) apartment and renting it out.

Once you own your home, you own the asset. That gives you more freedom of what to do with that asset compared to someone who rents.

The more income you can generate from your primary home, the more the math favors buying over renting. Of course, you will need to factor in the risk and time associated with becoming a landlord, but the opportunity is there.

There is a reason homeownership is so popular

If we lived in a purely rational world where the incentives were equal between renting or buying a home, a lot more people would rent.

Unfourtantley, the world we live in is far from rational. When you consider the fact that most renters would not invest enough of the money they save, the forced savings provided by a mortgage payment, the tax incentives, and the opportunity for house hacks; the numbers begin to favor owning vs. renting.

That does not mean owning a home is always the right choice. First, you need to decide if you are in a financial position to be a homeowner.

Then you can use the 5% rule as a starting point on your rent vs. buy decision. But like with all financial rules of thumb, the 5% rule should be where your research begins, not where it ends.

Thinking of buying a home?

If you are thinking of buying a home, I invite you to enroll in my class on Skillshare called “How to save for a house in 5 simple steps.” Where you will learn how to build a savings plan that will turn the dream of homeownership into a reality.

In the interest of full disclosure, I do receive a referral fee from SkillShare if you sign up for the free trial. It does not cost you anything if you cancel before the trial ends and helps us keep this publication going.

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.

The 5% Rule Revisited (2024)


The 5% Rule Revisited? ›

Multiply the value of the home by 5%, then divide that number by 12 to get your breakeven point. If the monthly rent on a comparable home is below the breakeven point, it makes financial sense to rent. If the monthly rent is higher than the breakeven point, it makes financial sense to buy.

What is the 5 percent rule example? ›

Take the value of the home you are considering, multiply it by 5%, and divide by 12 months. If you can rent for less than that, renting may be a sensible financial decision. For example, you could estimate about $25,000 in annual, unrecoverable costs for a $500,000 home, or $2,083 per month. It goes the other way, too.

What is the 5 value rule? ›

The rule of five is a rule of thumb in statistics that estimates the median of a population by choosing a random sample of five from that population. It states that there is a 93.75% chance that the median value of a population is between the smallest and largest values in any random sample of five.

What is the 5% rule in real estate investing? ›

Applying the 5% rule would look like this: Multiply the value of the property you own/like to obtain by 5%. Divide by 12 (to get a monthly amount). If the resulting amount is costlier than you would pay to rent an equivalent property, renting your home and investing your money in rental properties may work better.

What is the 5 percent rule Ben Felix? ›

The 5% rule is a great way to determine if you're ready to buy because it compares three costs that homeowners face that renters do not. The three expenses include property taxes, maintenance costs, and the cost of capital. Keep in mind that the 5% rule was formulated by Ben Felix for the Canadian real estate market.

What is the 95% vs 5% rule? ›

Have you ever heard of the 95-5 Rule? It goes like this: About 95 percent of problems, symptoms, issues, and challenges can be effectively addressed by making significant changes to only 5 percent of the processes, the people, or the technology.

What is the 5 by 5 rule explanation? ›

The idea behind the 5-by-5 rule is pretty straightforward. If something won't matter five years down the line, don't bother wasting more than five minutes obsessing over it.

What is the simple rule of 5? ›

The divisibility rule of 5 states that if the digit on the units place, that is, the last digit of a given number is 5 or 0, then such a number is divisible by 5. For example, in 39865, the last digit is 5, hence, the number is completely divisible by 5.

What is the rule number 5 in love? ›

Rule #5: You Can't Trust the Bad Boy (The Rules of Love)

What is the business rule of 5? ›

Every dollar spent on growth must produce 5 dollars in revenue. I call this the 5X rule. Successful, growing businesses make 5 times what they spend on marketing, advertising, sales or any other growth channel.

What is the 7% rule in real estate? ›

The top 7% are hustlers. If they don't know something, they'll learn it. If the heat is on, they'll put in the extra hours to make it happen. You don't have to know everything, everyone, have all the money, or talent, but if you'll apply those two principles, you'll do very well in real estate.

What is the 4 3 2 1 rule in real estate? ›

4-3-2-1 rule

The front quarter of the standard site receives 40% of the total value. The second quarter receives 30% of the total value. The third quarter receives 20% of the total value; and the rear quarter receives just 10% of the total value.

What is the 80% rule in real estate? ›

The 80% rule means that an insurer will only fully cover the cost of damage to a house if the owner has purchased insurance coverage equal to at least 80% of the house's total replacement value.

Is it always better to buy then rent? ›

If you're only going to live in a place for only a year or two, renting makes more sense. However, if you're going to stay there for three years or more, then buying would be a good idea and it becomes a better idea the longer you stay.

What is the rule of thumb for rent vs buy? ›

The price-to-rent ratio: Take a monthly rent figure and multiply it by 12, so it's an annual number. Divide the purchase price of a similar property by that annual rent number. A ratio greater than 20 generally weighs in favor of renting, while a figure less than 20 generally favors buying.

What are the unrecoverable costs of home ownership? ›

The total unrecoverable cost of ownership is up to 8% of the home value each year. As the mortgage gets paid down, the mortgage interest costs go away and are replaced by the opportunity cost of home equity. Once you are mortgage-free, you are left with the 4% opportunity cost of home equity.

What is 95 v 99 confidence interval? ›

With a 95 percent confidence interval, you have a 5 percent chance of being wrong. With a 90 percent confidence interval, you have a 10 percent chance of being wrong. A 99 percent confidence interval would be wider than a 95 percent confidence interval (for example, plus or minus 4.5 percent instead of 3.5 percent).

What is 95 confidence limit? ›

88 – (1.96 x 0.53) = 86.96 mmHg. This is called the 95% confidence interval , and we can say that there is only a 5% chance that the range 86.96 to 89.04 mmHg excludes the mean of the population. If we take the mean plus or minus three times its standard error, the range would be 86.41 to 89.59.

What is the 95 5 rule marketing week? ›

For us, the most fundamental principle in B2B (and B2C) marketing is the 95/5 rule, as articulated by Professor John Dawes of the Ehrenberg-Bass Institute. The concept is simple: at any given time, 95% of customers are out-of-market, and only 5% of customers are in-market.

Is the 5 by 5 rule good? ›

The 5 by 5 rule is an excellent technique to make a habit in your daily life. It will significantly reduce the amount of stress, worry and anxiety you experience on a daily basis. Remember, if it's not going to matter in 5 years, don't spend more than 5 minutes being upset about it.

What is the four fifths rule for dummies? ›

The Four-Fifths rule states that if the selection rate for a certain group is less than 80 percent of that of the group with the highest selection rate, there is adverse impact on that group.

What is the 5x5 rule of happiness? ›

The 5x5 rule states that if you come across an issue take a moment to think whether or not it will matter in 5 years. If it won't, don't spend more than 5 minutes stressing out about it.

Why is it called the rule of 5? ›

According to Lipinski's rule of five, an orally active drug can have no more than one violation of these conditions. The name "rule of five" comes from the fact that all the conditions have multiples of five as the determinant conditions.

What is the name of rule of 5? ›

A general “rule of thumb” for valuation of drug-like properties, known as Lipinski's rule of 5 (Ro5), has been introduced for almost 2 decades,2 which is a generally accepted method to predict drugs' ADME (“absorption, distribution, metabolism, and excretion”) performance mainly for oral drugs.

What is rule of 5 functions? ›

The rule of 5 states that if a class has a user-declared destructor, copy constructor, copy assignment constructor, move constructor, or move assignment constructor, then it must have the other 4.

What is rule 5 in life? ›

12 Rules for Life Rule 5: Do not let your children do anything that makes you dislike them Summary & Analysis | LitCharts.

What does 5 mean in relationship? ›

If someone is in a relationship with numerology number 5, they tend to be loyal to their partners. These people are extremely great at flirting. But, when they are in a relationship with someone, these people wouldn't cheat or break free. They don't make unnecessary rules around their partner or behave possessively.

What does the number 5 symbolize? ›

According to numerology, the number five symbolizes freedom, curiosity, and change – a desire to have adventures and explore new possibilities. But it signifies more than just high energy and excitement. From biology and astronomy to faith and religion, the number five has special meaning and significance.

What is the golden rule for every business? ›

The Golden Rule demands that every customer and situation be treated with kindness and thoughtfulness. Such consideration of others can lead to companies performing better than expected.

What is the golden rule for business? ›

"Treat others as you would want to be treated," the Golden Rule is short, succinct and powerful.

What is the 3 3 3 rule in business? ›

"Spend three hours on my most important current project, having defined some kind of specific goal for the progress I aim to make on it that day" "Complete three shorter tasks, usually urgent to-dos or 'sticky' tasks I've been avoiding, usually just a few minutes each (I count calls and meetings here too)"

What is 50 rule in real estate? ›

Like many rules of real estate investing, the 50 percent rule isn't always accurate, but it can be a helpful way to estimate expenses for rental property. To use it, an investor takes the property's gross rent and multiplies it by 50 percent, providing the estimated monthly operating expenses. That sounds easy, right?

What is the Brrrr method? ›

The BRRRR (Buy, Rehab, Rent, Refinance, Repeat) Method is a real estate investment approach that involves flipping a distressed property, renting it out and then getting a cash-out refinance on it to fund further rental property investments.

What is the 10% rule in real estate? ›

A good rule is that a 1% increase in interest rates will equal 10% less you are able to borrow but still keep your same monthly payment. It's said that when interest rates climb, every 1% increase in rate will decrease your buying power by 10%. The higher the interest rate, the higher your monthly payment.

What is the 2% rule? ›

The 2% rule is the same as the 1% rule – it just uses a different number. The 2% rule states that the monthly rent for an investment property should be equal to or no less than 2% of the purchase price. Here's an example of the 2% rule for a home with the purchase price of $150,000: $150,000 x 0.02 = $3,000.

What is the 0.8 rule in real estate? ›

This general guideline suggests that you charge around 1% (or within 0.8-1.1%) of your property's total market value as monthly rent payments. A property valued at $200,000, for instance, would rent for $2,000 a month, or within a range of $1,600-$2,200.

Is the 1% rule realistic? ›

The 1% rule is a guideline that real estate investors use to choose viable investment options for their portfolios. Although the rule has helped many investors make wise decisions regarding their investment properties, the current real estate market may make following the 1% rule unrealistic.

What is Rule 70 in real estate? ›

The 70% rule can help flippers when they're scouring real estate listings for potential investment opportunities. Basically, the rule says real estate investors should pay no more than 70% of a property's after-repair value (ARV) minus the cost of the repairs necessary to renovate the home.

What is the 25 rule in real estate? ›

To calculate how much house you can afford, use the 25% rule—never spend more than 25% of your monthly take-home pay (after tax) on monthly mortgage payments.

What is the 20 percent rule in real estate? ›

According to the 20/10 rule, you should limit your non-housing debt to twenty percent of your annual net income and keep your monthly payments for that debt to less than ten percent of the monthly net amount.

Why the rich are renting instead of buying? ›

RentCafe chalked it up to a matter of “comfort and smart investing.” Owning a home can come with more than its fair share of maintenance and costly repairs and upkeep. Then there's the flexibility renting offers one to move from city to city for career opportunities.

Why renting is smarter than buying? ›

Unlike homeowners, renters have no maintenance costs or repair bills and they don't have to pay property taxes. Amenities that are generally free for renters aren't for homeowners, who have to pay for installation and maintenance.

Is it smarter to rent or own? ›

Buying a house gives you ownership, privacy and home equity, but the expensive repairs, taxes, interest and insurance can really get you. Renting a home or apartment is lower maintenance and gives you more flexibility to move. But you may have to deal with rent increases, loud neighbors or a grumpy landlord.

What is the 100X rule in real estate? ›

A common real estate investing rule a savvy real estate investor follows is to pay no more than 100X the monthly rent as the purchase price. In my example, an investor wouldn't pay more than $900,000 for my now $9,000 a month rental house.

How do you calculate if a rental is worth buying? ›

All the one-percent rule says is that a property should rent for one-percent or more of its total upfront cost. For example: A property that costs $100,000 should rent for at least $1,000 per month. A property that costs $200,000 should rent for at least $2,000 per month.

What is the max percentage you should spend on rent? ›

A popular standard for budgeting rent is to follow the 30% rule, where you spend a maximum of 30% of your monthly income before taxes (your gross income) on your rent.

What is the biggest cost after buying a house? ›

Mortgage payments

Your mortgage payment will probably be your biggest ongoing expense as a homeowner. Mortgage payments include the principal, or the amount you borrowed to buy the home, as well as interest.

How do you know if a house costs too much? ›

13 Alarming Signs Your Home is Too Expensive (and 3 Ways You Can Fix It)
  1. Your mortgage is more than 28% of your income. ...
  2. You worry about your property taxes. ...
  3. You can't keep up with maintenance. ...
  4. Your yard is a mess. ...
  5. You struggle with utility bills. ...
  6. You don't have an emergency fund. ...
  7. You keep busting your budget.
Jul 13, 2022

What should you financially have in place before you buy a home? ›

When you buy a house, you'll need to have funds ready to cover closing costs. On top of that, plan to have enough cash reserves on hand to cover three to six months of expenses. You'll also generally need to make a down payment, though there are some loan programs that don't require you to put anything down.

What is the 5 percent rule in rent vs buy? ›

Multiply the value of the home by 5%, then divide that number by 12 to get your breakeven point. If the monthly rent on a comparable home is below the breakeven point, it makes financial sense to rent. If the monthly rent is higher than the breakeven point, it makes financial sense to buy.

What does the 5 policy apply to? ›

The 5% policy applies to secondary market trades, which include proceeds transactions (using sale proceeds to buy another security) and riskless or simultaneous transactions. A broker-dealer that is always willing to buy and/or sell shares of stock is considered a market maker.

How do you calculate percentage rule? ›

Percentage Formula

To determine the percentage, we have to divide the value by the total value and then multiply the resultant by 100.

What is 5 percent out of 100? ›

Answer: 5% of 100 is 5.

What is a percentage for dummies? ›

To write a percentage as a decimal, simply divide it by 100.

For example, 50% becomes 0.5, 20% becomes 0.2, 1% becomes 0.01 and so on. We can calculate percentages using this knowledge. 50% is the same as a half, so 50% of 10 is 5, because five is half of 10 (10 ÷ 2). The decimal of 50% is 0.5.

What is the formula to get the selling price? ›

How to Calculate Selling Price Per Unit. Determine the total cost of all units purchased. Divide the total cost by the number of units purchased to get the cost price. Use the selling price formula to calculate the final price: Selling Price = Cost Price + Profit Margin.

Is the 30% rent rule realistic? ›

Try the 30% rule. One popular rule of thumb is the 30% rule, which says to spend around 30% of your gross income on rent. So if you earn $3,200 per month before taxes, you should spend about $960 per month on rent. This is a solid guideline, but it's not one-size-fits-all advice.

Is it smarter to buy than rent? ›

Buying a house gives you ownership, privacy and home equity, but the expensive repairs, taxes, interest and insurance can really get you. Renting a home or apartment is lower maintenance and gives you more flexibility to move. But you may have to deal with rent increases, loud neighbors or a grumpy landlord.

What is the 2% rule of thumb for rental property? ›

The 2% rule is the same as the 1% rule – it just uses a different number. The 2% rule states that the monthly rent for an investment property should be equal to or no less than 2% of the purchase price. Here's an example of the 2% rule for a home with the purchase price of $150,000: $150,000 x 0.02 = $3,000.

What are policy rules? ›

Policy rules provide useful benchmarks for setting and assessing the stance of monetary policy. Well-specified rules are appealing because they incorporate the key principles of good monetary policy discussed in Principles for the Conduct of Monetary Policy, but they nevertheless have shortcomings.

What is the 3 percentage rule? ›

As a result, retirement experts have downgraded the Four Percent Rule to the Three Percent Rule. In short, to enjoy a reasonably high expectation of not running out of money prior to death, you should never withdraw more than three percent of your initial portfolio value in retirement.

What is the rule of 72 percentage? ›

What is the Rule of 72? The Rule of 72 is a calculation that estimates the number of years it takes to double your money at a specified rate of return. If, for example, your account earns 4 percent, divide 72 by 4 to get the number of years it will take for your money to double. In this case, 18 years.

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