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2013-08-21 10:31:21
The Five Year Rule for Buying a House

THE FIVE YEAR RULE
FOR BUYING A HOUSE

 

The Upgrade Cycle
A lot of people will buy a townhouse or condo as their starter home.  After about three years, they will start looking for a larger 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 home that they are happy with and that is big enough for their family. 

If you are making a little more money every year, you will be in a position to afford a bigger house in three years time.  Everyone 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. 

 

The Five Year Rule
When you purchase a house, the rule is that you want to be sure you will be in the same location for at least five years Otherwise, you are probably going to take a hit financially.

The first hit is your closing costs.  Everytime you close on a home - buying and selling - 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.

The second hit is 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.  It isn't until you are 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.

When you take out a mortgage, you are paying an interest rate on what you owe.  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 (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.

 


Defeating the Five Year Rule
The biggest factor is how much you are going to pay on your mortgage.  A lot of people will buy as much house as they can aford, according to what lenders offer them.  If you buy at the lower end of what you can afford and make extra payments, you can pay off a larger chunk of the principal. 

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 is not out of the question to purchase a house, start paying it down and fix it up so that you can turn around and rent it out.  You 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.  Be sure to study up on real estate before making such a choice.

 


Here is a quick formula that you can use to help figure out whether it is better to buy or rent in any duration of ownership.  Try to calculate the following:
 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.  If it is 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 the selling price wasn't high enough to cover all costs, then renting would be the more cost-effective choice.

 

Information taken from article entitled 'The Five Year Rule for Buying a House' on Moneyning.com at: http://moneyning.com/housing/the-five-year-rule-for-buying-a-house/

 

 
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