ON THE MONEY: The 5% rule for a home purchase | Features


Couples who are considering the purchase of a new home should consider whether it is better to rent or buy. One helpful way to make that comparison is by using what is typically the 5% rule (which is an oversimplification but a useful tool nonetheless).

We need to determine those expenses of buying a new home that you will not recover. These would include property taxes, maintenance costs, and what I would classify as lost opportunity costs.

Property taxes in South Carolina are typically lower than the national average and you can find out what your projected property will be before you plunk down any money to buy the home. State-wide, the average rate is .55%. Those taxes do not increase the value of your home and are thus non-recoverable.

For purposes of this comparison however, we will assume that property taxes are 1% of the value of the residence.

The expense of maintaining your residence is another cost that does not add value to it. Naturally, maintenance costs are higher if you buy a home that is not new. For simplicity’s sake, assume that the annual maintenance costs are 1%

Since most new home buyers will make a down payment of 20% of the cost of the property, another cost of a home purchase you can never recoup is the income you could be reasonably be expected to have earned if you had invested your down payment in an alternative investment.

Over the long haul, residential values have risen by 3% annually. Admittedly, real estate values in Aiken are now through the roof, but future increases of the same magnitude are problematic. Next, we need to compare our 3% return from buying with the average return of alternative equity investments if we rent and invest that money.

Again, for ease of comparison, let us be conservative and assume that equities should average a 6% return each year, which is 3% greater than buying. The total costs you can’t recover from buying are 2% for taxes and maintenance and 3% for “lost investment opportunity costs, totaling 5% in non-recoverable costs for buying a home.

Say you considering the purchase of a $200,000 residence. Multiply that price by 5% and divide by 12 months. If you can rent for less than $833 per month, then renting makes the most financial sense.

Bear in mind that you can determine your personal non-recoverable costs of buying and the percentage could be higher or lower.

Believe it or not, I was the intended victim of a scam this week. I received an innocuous looking e-mail from the head of a state-wide organization of which I am a member. Although philanthropic activities are not the major thrust of this organization, it is not unusual for us to make charitable bequests to worthwhile organizations. In the email, our chairman asked me to purchase five gift cards from Walmart for $200 each to be mailed to the charity. She further indicated that she was out of the state and would reimburse me upon her return. That request sounder reasonable to me before I started thinking about the email.

Why on earth would our chairman not send me a check for $1000 and have me purchase the cards directly? I finally woke up from my stupor and recognized this as a scam. I immediately called our chairman to inform her of the scam. It tuned out that every board member received the same email.

We have a web site and all of the board members’ names and email addresses are on that site, so we were easy pickings for this scammer.

The moral of the story is clear: If you are ever asked to send gift cards or any other near-cash items to another person or entity for later reimbursement, you are being scammed!


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