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Renting vs. Buying a Home: The 5% Rule

Please be aware that whereas this content material is broadly relevant, it was initially supposed for a Canadian viewers.

You cannot examine lease to a mortgage cost. This mind-set in regards to the lease versus purchase determination is extraordinarily flawed. Comparing a mortgage cost to lease is just not an apples to apples comparability. In order to correctly assess the lease versus purchase determination, we have to examine the full *unrecoverable prices* of renting to the full unrecoverable prices of proudly owning.

That might sound like a sophisticated process, however I’ve boiled it all the way down to a easy calculation.

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21 Comments

  1. You're not accounting for the transaction costs incurred when buying and selling – primarily broker's commission when selling. Time horizon becomes a significant factor in the calculation.

  2. How does this formula work if I am Airbnb-ing 2/4 bedrooms and am making half of my mortgage payment? Is it better to own or rent? Or what if I take my capital and put it into another
    primary leaving the original partial Airbnb house to go fully to rent and thus cash flow $500 every month? And what if I keep using the cash flow and capital at hand as purchasing power to repeat this process once or twice a year? It seems like the potential to leverage and cash flow a structure that is ordinarily used as shelter can only be utilized by ownership.

  3. Your home will usually appreciate more than the low mortgage cost. Stocks however may not outperform the margin account's borrowing costs (which are much higher than mortgage rates).

    True value in owning a home is the cheap leverage available which can make your return much higher than unlevered stock returns (or levered returns with expensive debt).

    The 5% rule is really interesting, but might have to adjust the cost of capital portion way down for the above reason.

  4. Advice : if you have the money, or have a job and can save towards owning your house, go for it.
    Ignore the money and go for the freedom and peace of living in your own house, being able to upgrade the house and so on.

  5. Don't we want to factor in unrecoverable cost related to the transaction? Both buying and selling a home incur cost, so you would want to factor that in based on how long you may stay in the place you are buying?

  6. This guy misses the Expected rate of return for property which are commercial in nature! Higher return and appreciation in value. Secondly why not by Debt in countries with fail safe Treasury Bills at 7.5% per annum and low risk and enjoy a better life!

  7. So much wrong with this. Here's the truth: If you were to compare buying a house vs renting that same house, it is smarter to buy 99% of the time in the US. The only exceptions are isolated foreclosure areas.

  8. 2 problems with this analysis.
    1. Rents usually go up. Owning a home shields you from rising rent.
    2. The home's value usually goes up. In return for spending that unrecoverable cost you get an appreciating asset.
    In most real estate markets owning would be a terrible deal if real estate costs were fixed. You take a financial bath the first few years. It only becomes worth it 5-10 years down the road when the rents are higher and you have built equity in the home.

  9. Great video, but with respect to taxes, there's no argument that the US and Canada use their taxes dramatically different on their people. Canadians are taxes higher but in return, you guys have excellent social programs, but for us Americans, our taxes are keeping the global military empire afloat! Ultimately, America is run like a business, where houses don't create memories (Warren Buffett's own quote) but equity and are more of an investment, and I'm guessing Canadians actually end up becoming true home owners relatively sooner instead of after the proverbial 30-year mortgage, but I'm not sure. My point…do your damn research, people! Make an informed decision, and whether it's renting or buying, make sure to actually live your life and create lasting memories, not just equity or diversifying your portfolio!

  10. I may have missed it but I don't think you're factoring in the effect of leverage in your cost of capital calc. The return you're receiving on the home isn't just on the 20% you put down, it's on 100% of the home's value. Most people couldn't get that amount of leverage in a margin account. Taking it a step further, you could use the Smith maneuver (for Canadians who can't write off the mortgage interest) to reduce the cost of debt portion of your cost of capital (i.e., tax deductible), but that's not something the average person should be dabbling in. Taking these into consideration could substantially change your rule of thumb.

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