The Five Year Rule for Buying a House

by Thursday Bram · 252 comments

Handing over the keys when buying a house

When I first considered buying a house, my entire family got involved. I have the luck of being related to real estate agents, investors, and other experts that are more than happy to give advice about buying a property — even before you ask.
The first thing they asked me was exactly how long I expected to stay in the house. Though I didn’t know the exact amount of time, they wanted to make sure that I’d own the house for at least five years.
Why’s that? What’s the five year rule for buying a house?

The Upgrade Cycle

It definitely varies by geographic area — if not by specific neighborhood — but a lot of folks near me will buy a townhouse or condo as their starter home. After about three years, they’ll start looking for a bigger place to upgrade to, either a bigger townhouse or a single family home. This upgrade cycle will repeat itself a few times, as people work their way up to a house that they are happy with and that is big enough for their family.
The thought seems to be that if you’re making a little more money every year, you’ll be in a position to afford a bigger house in three years time. And everyone ~~knows~~ assumes that buying is more cost-effective than renting — as long as you’re paying down the principal on your mortgage, you’re going to come out ahead.
But with an upgrade cycle of about three years, there’s a good chance that you will lose money.

The Five Year Rule

When you purchase a house, the general rule is that you want to be sure you’ll be in the same location for at least five years. Otherwise, you’re probably going to take a hit financially.
The first hit is your closing costs. Every time you go through closing — buying and selling — money hits the table. Depending on where your house happens to be, the buyers and sellers pay different amounts, but everyone pays something. This can easily add up to thousands of dollars, and limiting how often you have to pay that kind of money is always a good idea.
And you take a second hit when you look at your mortgage statement to see exactly where your monthly payments are going. The way mortgages are structured, you pay much more interest in the first few years that you own a house. Usually, it isn’t until you’re about five years into paying down your mortgage that you’ve made enough progress on the principal to make it a better deal than paying rent each month.
David’s Note: When you take out a mortgage, you are paying an interest rate on what you owe. So, in the first year, when the principal is highest, the interest you need to pay is also the highest. However, since the monthly payment is the same throughout the term of the loan (at least with a fixed rate mortgage), more of the payment will be used to cover the interest payments, meaning less is going towards the principal. As your principal goes down, your interest payments will go down, leaving more of your check to go towards the principal.
If you can wait at least five years to move, you’re in a better position to be ahead of the game.

Defeating the Five Year Rule

Five years is a generality. If you add in a couple of other factors, you can make buying a house that you don’t plan to stay in long-term a better choice.
The biggest factor is how much you’re going to pay on your mortgage. A lot of people buy as much house as they can afford, according to what lenders offer them. That’s usually the upper end of what you can financially manage. If, however, you buy at the lower end of what you can afford and make extra payments, you can pay off a bigger chunk of the principal. You need to run the numbers for the specific house you’ve got your eye on, but you can often come out ahead.
You may also consider buying a house that you won’t stay in for five years — but that you also won’t turn around and sell. It’s not out of the question to purchase a house, start paying it down, and fix it up so that you can turn rent it out. You do need to be careful that you’re choosing a house that you can afford in addition to a mortgage for your next home, even if you can’t find a renter,. There are plenty of other arrangements that can work out similarly, but you need to study up on real estate before making such a choice.
[Click here for a discussion on whether you should buy an investment property.]
Bottom line: if you know you’re going to buy a house based on what the bank says you can afford, and you don’t want to think about renting it out, don’t purchase a house until you’re ready to spend at least five years in it.
David’s Note: Here’s a quick and dirty formula that you can use to help you figure out whether it’s better to buy or rent, which works with any duration of ownership. Try to calculate: Seller and Buyer Agent Fees When You Sell + Purchase Price + Maintenance Cost for the Time of Occupancy + Interest Paid on Mortgage + Investment Gains from Your Down Payment + Taxes Paid (Such as Property Tax) + Closing Costs – Selling Price. This number could come out negative or positive, but if it’s lower than the rent you would have paid during the same time frame, then you would be better off buying. If the number is higher, meaning that the selling price wasn’t high enough to cover all those costs, then renting would be the more cost-effective choice.
Do you adhere to the five year rule when buying a house?

Tagged as: Housing, Investing, Real Estate

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{ 252 comments… read them below or add one }

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peter horne October 30, 2012 at 10:28 am

The list of “costs” used to compare to rents seems to be missing the tax deduction. Most middle income folks are either in 28% or lower end of 33% marginal rates. In addition there may be incentives for certain homes – energy rebates etc. – that mean the actual cost of ownership is somewhat less than adding up all of the closing costs etc.

Greg January 18, 2013 at 5:10 pm

You said, “Most middle income folks are either in 28% or lower end of 33% marginal rates.”
I checked, and this seems strange to me given that median U.S. household income is around 50k. With deductions, the vast majority of Americans, including all middle income by any reasonable distribution, fall into 10%, 15%, and 25% tax brackets. If one runs in circles where most of his/her friends make 146k+, you are doing very well … and kudos (seriously) … just realize and appreciate that you are in actually very rare air.

gtsga January 30, 2013 at 5:06 pm

Honestly man, I cannot imagine how families survive on less than $100k/year. Of course that depends on where you live and cost of living but let’s assume it’s a major metro area. $100k/year won’t even pay the most basic of life styles.
Ten years ago my wife at the time and I made about $250k/year combined, lived in a modest $175k home, had 2 car payments and 2 kids. After the government got their unreasonably high share of our hard-earned income, we payed our essential bills and contributed the maximum to retirement savings, we had nothing left of any consequence. We realize we were fortunate which made us wonder how in gods name families could survive on $50k/year or even $100k/year.
The US needs serious adjustments to middle-class taxation. Income below $200k/year needs much lower taxation and income, of ANY kind, above a couple million/year needs significantly MORE taxation. When we just got married and collectively made $35k/year, lived in an apartment and worked our way through school, we barely survived. The lower-middle class families in this country deserve better.

Jim Fawcett February 11, 2013 at 12:19 pm

I wish with all my heart I could pay your unreasonable share of your so-called hard earned income in taxes. I make 30k a year, gross. Thank God the Houston area where I live is pretty cheap. Quit complaining about your ‘unreasonable’ taxes and next time you pay them, thank God you earn enough to afford it. You make me sick. And I seriously doubt you work harder than I do. Try working 12 hours a day in the fields!

b February 19, 2013 at 9:54 am: Maybe if you spend less time leaving comments on random articles you would have more time to increase your skill set and in turn receive higher compensation.
scabbert February 21, 2013 at 6:51 am: b,
So non-rich people aren’t allowed to have an opinion on the internet. Got it.
What an awfully obtuse statement yours is, so packed as it is full of hidden, false assumptions and sneering disdain.

realistic February 13, 2013 at 8:33 am

If you can’t survive on $250k/yr, you have some “serious” money management issues.

CMS November 28, 2012 at 11:47 am

@Peter, many Americans dont have enough itemized deductions to take the mortgage so reality is if you dont make $100K+ a year or live in a tax hellhole you likely wont get any rebate. The mortgage deduc is an upper middle class tax break.

Heinz November 29, 2012 at 9:34 am

my primary residents is in California,I also own a home in Costa Rica.
If I sell the home in CR will I have to pay US capital gains tax,after I have paid tax in CR ?
Thank you
Heinz

Glenn December 27, 2012 at 9:03 am: Yes

Reply

Hanna Ann December 11, 2012 at 1:19 am

This is the primary rule for buying a house. After buying house, you can apply insulation in your house as a way of heat transfer.

Chris January 1, 2013 at 7:48 am

The 3 biggest risks to your finances are:
-unemployment
-divorce
-health problems
make sure you take care of those items first before worrying about anything else.

gtsga January 30, 2013 at 5:10 pm: You need a 4th:
Over-bloated government spending and the subsequent increased taxation.
Put retirement planning back in the hands of citizens, eliminate the retarded social security nonsense and things might be different.

Reply

Abigial fernandes January 9, 2013 at 8:38 pm

Hello sir,
I want a house were i could stay forever and work with my family. I am just 18 yrs. I want to buy with my own money. and settle there with them. I would like to gift a house for my family. I would like if u understand my feeling. And they like to visit in California. I would like to know the proper amount of your house and i would like to bring them in the month of December 2013.
Abigial Fernandes
From Goa.

anon January 11, 2013 at 5:24 am

I am looking at buying a house that currently rents at 300-350/month
What price should i offer as a general rule?

realistic February 13, 2013 at 8:36 am: Depends on:
Where it is
Condition
Appraisal value
How deep are your pockets

Reply

Joe February 1, 2013 at 12:15 am

Very outdated analysis. With interest rates around 3% a very large part goes to principle starting month one (compared to just a few years ago when 7-8% was normal).
Buy a house you want to live in and can afford, everyone has a different take on that because different people have different income levels and the amount they can put down.

MSG February 4, 2013 at 10:29 pm

Put your money in a place were its
-Safe
-Liquid
-0 to 12% Rate of return guaranteed
-Maximum upside potential with no downside risk
-Accumulates tax free and withdraw tax free
-Blossoms in value

Eric February 11, 2013 at 2:15 pm

Another consideration with regards to taxes and interest paid is the deduction that you get each year for the interest paid on the loan. Granted that is taken off your gross and in reality equals only your taxe rate percentage and not the total amount, however if you are paying a 28-32% that means that your effective cost of your loan is reduced by reducing your income tax burden, equity is gained and you are paying on an assest that you can sell or rent later. This is a deduction afforded everyone regardless of income levels. Additionally, with a 30 year fixed rate mortgage, your monthly costs will go down when taking into account inflation (especially with 3-4% loans) and even though local taxes might increase, again they are a deduction off your Fed income tax. All of that beats throwing money at just renting. The key is to buy what you can afford, not necessarily what you think you deserve. In that scenario you will come out okay, regardless of how much you hate the government or taxes or all the other things you don’t have any real control over. With the ratching down on credit that has occurred (the “whys” of that is whole other topic), more and more folks are going to be put in a position that they can only rent, which is going to be good for the property owners who have a desire to rent. My take on this topic is to buy what you can in an area that has potential upside and growth, compromise on the whole “dream house” idea with a first house and get into something affordable as quickly as you can before interest rates go up or inflation starts to kick in again (always does, economics is cyclical).

Randy K February 19, 2013 at 1:54 pm: The deduction for mortgage interest doesn’t help you at all if that plus other things you can deduct don’t exceed the standard deduction. I only financed 125k on my house, and at 4.8% interest, married filing jointly, and even adding in state and property taxes, etc. itemizing doesn’t get me to the standard deduction. And every year that deduction becomes smaller because there is less interest paid (Not that I want to pay more interest!). Ownership is still a win for me because my mortgage is $300/month less than renting comparable houses in my area, though. Even the apartment we lived in before buying the house had a higher rent than my PITI.

Reply

Living like a king February 12, 2013 at 9:54 am

Some people hate taxes but yet they want traffic lights, side walks, schools fire protection (think insurance), police, highways, the list goes on. None of that is free and someone has to pay for it and as users we pay. I don’t like taxes but until someone has a better idea we have to live with what we have. Don’t complain too much until you can do something about it. Just live within your means and not your credit cards means. You want to impress people than you pay with where you live, drive, and wear. That simple.

Common Sense February 13, 2013 at 7:10 pm

LLAK, I don’t know anyone who complains about funding the government and government services perse. The complaints come because politicians from both sides of the aisle treat our hard-earned money like their own personal campaign funds! They don’t respect the $ they spend. It’s like Monopoly Money to them…not OUR hard-earned dollars!!

JB February 15, 2013 at 1:45 pm

Big diference between local taxes and the money our lovely federal government grabs every month.
Have any of you wondered what retirement would look like if we had the 12% of our income social security took (6% from the individual, 6% from the employer) and were allowed to invest it ourselves?

KS February 18, 2013 at 12:52 pm: It depends on how much you earn and how long.
1. If you are high income earner and worked for over 30 years, you will have a much better retirement.
2. If you are low income earner and/or disabled your quality of life will be much less.

Reply

CPA February 25, 2013 at 2:01 pm

Yeah… those things cost like 1/1000th of a percent of what the rest of our federal expenditures are (particularly social security, medicare, medicaid). Most of the items you listed are local or state anyway, not federal. So you should go back to the drawing board for a better argument.

WI CPA March 10, 2013 at 6:59 pm

If people either take out a 15 year loan or have a 30 year loan but pay it off in 15 they will be saving a lot in interest. Granted your tax deduction on the interest will go decrease faster, but it is a good way to build up the equity quickly. Granted it is nice to get an interest tax deduction but its nice to have your house paid off and you aren’t making any payments.

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