Rent vs Buy: How to Decide With the 5% Rule

Buying a home usually makes sense if you plan to stay at least five years, have a stable income, and the total cost of owning is close to what you would pay in rent. Renting can be the better money move if you might move soon, if homes in your area are very expensive compared with rents, or if buying would drain your savings. Neither is automatically “throwing money away”.

The real costs of each

Renting: rent, renter’s insurance, and the occasional move. That is about it.

Owning: much more than the mortgage payment.

• Mortgage interest: the bulk of early payments. See 15 vs 30-year mortgage.
• Property tax: often 0.5% to 2% of the home’s value a year.
• Insurance and HOA fees.
• Maintenance and repairs: plan on about 1% of the home’s value a year.
• Buying and selling costs: closing costs of 2% to 5% when you buy, and 6% to 10% when you sell.
• The cost of your down payment: money tied up in the house could otherwise be invested.

The part of your payment that goes to principal is not a cost; it builds equity. That is the big advantage of owning.

The 5% rule: a quick comparison

A popular shortcut says the yearly costs of owning that you never get back add up to roughly 5% of the home’s value: about 1% property tax, 1% maintenance, and 3% for the cost of money (mortgage interest and the return your down payment could have earned).

So for a $400,000 home, 5% is $20,000 a year, or about $1,667 a month. If you can rent a similar home for less than that, renting and investing the difference may come out ahead. If rent is higher, buying looks better. Adjust the numbers for your local taxes and current mortgage rates.

Price-to-rent ratio

Divide the home price by a year of rent for a similar place. A $400,000 home that would rent for $2,000 a month ($24,000 a year) has a ratio of about 17.

• Under about 15: buying often makes sense.
• 15 to 20: it depends on your plans.
• Over about 20: renting is often the better deal, common in expensive cities.

When buying makes sense

• You plan to stay five years or more, so buying and selling costs are spread out.
• Your job and income are stable.
• You have a down payment plus an emergency fund left over.
• The payment fits your budget. Check with how much house can I afford and the mortgage calculator.
• You value stability, control over your space, and not facing rent increases.

When renting makes sense

• You may move for work or are not sure about the city.
• Homes are very expensive compared with rents where you live.
• Buying would leave you with no savings cushion.
• You would rather not handle repairs and maintenance.
• You will actually invest the money you save. Renting only wins financially if the difference goes into something like low-cost index funds, not into spending.

Forced savings vs flexibility

One underrated benefit of owning is that a mortgage forces you to build wealth every month through equity. Renters who invest the difference consistently can match or beat that, but many people do not. On the other hand, renting gives flexibility to move for a better job, which can be worth far more than home equity over a career.

Canada and the UK

In Canada, the FHSA and RRSP Home Buyers’ Plan can help first-time buyers save for a down payment. In the UK, the Lifetime ISA adds a 25% bonus on first-home savings. Canadian buyers can estimate payments with CMHC insurance in our Canadian mortgage calculator.

Frequently asked questions

Is renting throwing money away?

No. Rent buys housing, just as mortgage interest, property tax and maintenance do for owners. Owners also have costs they never get back.

How long should I stay to make buying worth it?

Usually at least five years, sometimes more in expensive markets or when prices are flat.

Should I wait for mortgage rates to fall?

No one can time rates reliably. If buying fits your life and budget now, you can refinance later if rates drop.

This article is general information, not financial advice.