Rent vs Buy: The 5% Rule and Opportunity Cost

The American Dream tells you that "renting is throwing money away." Your parents tell you to "buy as soon as possible." But with interest rates hovering around 7% and home prices at historic highs, buying a home in 2025 might be the worst financial decision you make.

Or it might be the best. The answer isn't in the "feeling" of ownership; it's in the Unrecoverable Costs.

Key Takeaways

• Renting is not waste: Rent buys you shelter, flexibility, and zero maintenance liability.
• Buying has waste too: Property taxes, HOA fees, maintenance, and mortgage interest are all "thrown away" just like rent.
• The 5% Rule: A quick heuristic to compare monthly rent vs. purchase price.
• Opportunity Cost: The down payment you tie up in a house could be earning 8-10% in the stock market.

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1. The Unrecoverable Costs of Buying

When you pay $2,000 in rent, that money is gone. When you pay $3,500 for a mortgage, you think "I'm paying myself!" Wrong.

In the first few years of a mortgage, look at where the money goes:

1. Property Taxes: ~1-2% of home value (Gone).
2. Maintenance: ~1% of home value per year (Gone - roofs break, HVACs die).
3. HOA Fees: $300/mo (Gone).
4. Mortgage Interest: $2,000/mo (Gone to the bank).
5. Cost of Capital: The 5% you didn't earn on your down payment cash.

Only the tiny sliver remaining (Principal) is "paying yourself." The rest is the Cost of Housing.

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2. The 5% Rule (Heuristic)

This rule, popularized by Ben Felix, helps you compare instantly. The annual unrecoverable cost of owning a home is roughly 5% of the Total Home Value.

• 1% Property Tax
• 1% Maintenance cost
• 3% Cost of Capital (Interest rate spread or Opportunity cost)

The Test: Take the home price and multiply by 5%. Divide by 12. If you can rent a similar home for less than that number, RENTING is mathematically superior.

Example: $500,000 Condo

• Buy: $500,000 x 5% = $25,000/year unrecoverable cost (~$2,083/mo).
• Rent: Can you rent a similar condo for $1,800?
  • YES: Renting builds more wealth (if you invest the difference).
  • NO (Rent is $2,500): Buying builds more wealth.

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3. The "Forced Savings" Argument

The strongest argument for buying isn't math; it's behavior. Most renters do not invest the difference. They spend it on travel, cars, or dining out. Buying a home acts as a forced savings account. You have to pay the mortgage, and slowly, painfully, you build equity.

If you lack discipline to invest in the S&P 500 every month, buying real estate is a great safety net against your own spending habits.

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4. Flexibility is Worth Money

Buying has high transaction costs.

• Closing costs to buy: ~3-5%
• Agent fees to sell: ~6%

You lose ~10% of the home's value just moving in and out. If you plan to move in less than 5-7 years, renting is almost always cheaper because you avoid these massive transaction fees.

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5. Conclusion

Don't buy a house because of FOMO (Fear Of Missing Out). Buy a house when:

1. You plan to stay 7-10 years.
2. You have a healthy emergency fund for repairs.
3. The 5% Rule shows it's competitive with rent.
4. You want the lifestyle of ownership (painting walls, owning a dog, stability).

Owning a home is a lifestyle consumption choice with a forced savings component. It is not always the best investment.

👉 Check your Affordability first