Multiply the value of the house by 5% and then divide that number by 12 to get your breakeven point. If the monthly rent for a comparable home is below break-even, it makes financial sense to rent. If the monthly rent is higher than the breakeven point, it makes financial sense to buy. The 5% rule was coined by Canadian investment portfolio manager Ben Felix.
It stems from the general consensus among prospective homebuyers that if you can afford to make mortgage payments equal to or less than what you are paying for rent, then buying is a better alternative. However, the 5% rule puts the dilemma of buying versus renting in a different light by taking into account the irrecoverable costs that occur in both cases. When comparing the two options, renting can often get ahead, at least compared to the first few years of buying a home. But just like the turtle that runs with the hare, owning a home is more “slow and steady, a marathon rather than a sprint.
The virtues of buying grow when you stay in a house for a while. As the years go by and the equity and value of your home have the opportunity to increase, a smaller amount of each mortgage payment is used to pay interest and more goes to your principal. You can't compare rent to a mortgage payment. This way of thinking about the decision to rent versus buy is extremely flawed.
Comparing a mortgage payment to rent is not a comparison between apples and apples. To properly evaluate the decision to rent versus buy, we need to compare the total *irrecoverable* costs of renting with the total irrecoverable costs of the property. The 5% rule is well known to real estate specialists and you will often hear it mention if you plan to buy a house in the near future. In conclusion, Felix points out that if you are a conservative investor, you should use a 4% rule for your real estate purchase.
I prefer this strategy to speculating on a highly selected anomaly, such as Ontario's current real estate markets. However, every investment is different, and when it comes to real estate, there are a wide range of factors you should consider before making a well-informed decision.