The 5% Rule: A Simple Way to Decide Between Buying and Renting

Confused by complex calculators? The 5% rule provides a quick and effective way to compare the cost of renting vs. buying a home.

If you've been looking into the buy vs. rent debate, you've likely encountered complex spreadsheets and calculators. While detailed analysis is great, sometimes you need a quick "back-of-the-envelope" calculation to get a sense of the market. Enter the 5% Rule.

Popularized by financial experts, the 5% rule helps you estimate the "unrecoverable costs" of homeownership and compare them directly to rent.

What are Unrecoverable Costs?

When you rent, your unrecoverable cost is simple: it's the rent you pay. You'll never see that money again.

When you buy, people often think the "cost" is the EMI. But part of your EMI is principal repayment, which is essentially moving money from your bank account to your home's equity. The real unrecoverable costs of buying are:

1. Property Taxes: Usually around 1% of the home's value.
2. Maintenance Costs: Estimated at 1% of the home's value for upkeep and repairs.
3. Cost of Capital: Estimated at 3%. This is the most complex part. It represents the interest you pay on a mortgage OR the opportunity cost of not investing your down payment in the stock market.

Totaling these up: 1% + 1% + 3% = 5%.

How to Apply the Rule

To use the rule, follow these steps:

1. Take the total value of the home you want to buy.
2. Multiply it by 5% (0.05).
3. Divide by 12 to get the monthly "break-even" rent.

Example:

If a home costs ₹1 Crore ($120,000):

• ₹1,00,00,000 x 0.05 = ₹5,00,000 per year.
• ₹5,00,000 / 12 = ₹41,666 per month.

The Verdict:

• If you can rent a similar home for less than ₹41,666, renting is likely the better financial move.
• If the rent is more than ₹41,666, buying might be more advantageous.

Why Use the 5% Rule?

The 5% rule is powerful because it levels the playing field. It reminds us that owning a home isn't free—even if you've paid off the mortgage, you still have taxes, maintenance, and the opportunity cost of having your wealth tied up in brick and mortar.

Limitations

While useful, the 5% rule is a simplification. It doesn't account for:

• Local tax laws and incentives.
• Specific mortgage interest rates (if they are significantly higher or lower than 3% above inflation).
• Rapidly changing real estate markets.

For a more precise answer tailored to your specific situation, use our Buy vs Rent Calculator which factors in all these variables and more.