Housing is the most substantial monetary cost for the majority of people in their lives, thus making sound selections about our housing options is vital. Housing is much more than merely a financial or investment choice. There is a significant emotional element that goes into the selection of where to live, and it is one of the most essential necessities of every person's life. Considering all of this, it is critical to make sound decisions when determining where to live and how to live.
The 5% Rule
5% rule is the new way to decide between the renting decision and buying decision and it is becoming immensely popular among the investors. It is very useful and effective for determining whether you should keep on renting or if it is time for you to finally own your property.
Ben Felix, a Canadian financial portfolio manager, devised the 5% rule. He got to this conclusion by surveying potential homebuyers and discovering that if you can afford mortgage payments that are equivalent to or less than what you're spending on rent, purchasing is a superior option. The 5 percent rule, on the other hand, casts the purchasing vs. renting debate in a new light by accounting for the unrecoverable expenses that occur in both circumstances. These expenses can vary from individual to individual but they must occur in renting or buying decisions for every investor. Ben referred to these as unrecoverable costs.
What are unrecoverable costs?
The unrecoverable costs are different in renting and in buying. But despite being different they are going from the person’s profit.
In the case of renting, the monthly rent is an unrecoverable expenditure, paid by the tenet. The money spent will get you somewhere to live, but it will not help you own an asset as homeownership will. You can stay at a place for a decade or more, pay its rent every month, but still at the end after ending all this money, you will be a tenant. In short, you are spending money, but you won’t have ownership of an asset (housing) after all this expenditure. Furthermore, the instances in which it may be utilized to boost your credit score are still few, and they are primarily dependent on whether your landlord would disclose such payments to a credit agency.
In the case of buying, Ben highlighted the unrecoverable costs without including the mortgage payments. With the 5% rule comes into play, highlighting three sorts of unrecoverable costs and their estimations in case of buying are:
Property tax varies from country to country i.e. in the US it’s 1 % of the property value but in Pakistan, it is levied at the rate of 5% of annual value. Ben’s rule considered it 1%
Yearly maintenance expenditures are projected to be 1% of the property's worth.
The cost of capital, or mortgage interest rate (not the actual value of mortgage; only the percentage/value of interest on it), is predicted to be 3%. Here the cost of capital is calculated as: Cost of capital = cost of debt (mortgage) + cost of equity (downpayment of mortgage) Collectively, all these costs make the total of 5% (of yearly expense)
How does the 5% rule work?
The formula to calculate the 5% cost is “multiply the value of a property by 5%, then divide the number by 12”. The result of this is a monthly break-even point, which may help you evaluate if purchasing or renting is a better financial decision with your finances.
The above explanation is in theory. Here is how it practically works. Assume you want to buy a house in Islamabad, and the average price you can spend on it is roughly 10,000,000 rupees. Using the 5 percent rule, multiply this value by 5% and the answer will be 500,000. Then, divide this 500,000 by 12, and your monthly break-even mark is 41,666 rupees. This means that renting makes more sense if you can find a rental that prices less than that. However, if your rent exceeds 41,666 Rs per month, the better option for you is to purchase a property instead.
Is the 5% rule workable in Pakistan?
There is a lot of difference between how the Canadian real estate market works; from where Ben took his estimates, and how the Pakistani real estate market operates but the general skeleton of the 5% rule is totally workable and aid in making the right decisions when one has to decide between renting or buying in Pakistan. But before making any decision, especially if you are not very aware of the market, you should discuss both options and your finances with some credible real estate agent or a professional real estate agency.
Final Words
5% rule can be a very big help in choosing the right alternative from buying or renting but costs included in that and their calculation can be quite complicated. If you want to discuss it with real estate agents or looking for a real estate agency in Islamabad or in any other major city of Pakistan, Deal and Deals is the right choice for you. For more information visit : Capital Smart City Location and Map, Nova City Plot for Sale.
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