And no, it’s not “When Katie realized she couldn’t afford to buy," but good guess.
Feeling compelled to purchase a home is an urge fraught with emotion.
There’s a sense of ownership and empowerment that renting can’t offer in the same way buying does.
If you drive through the quaint-yet-inexplicably-impossible-to-afford areas of your town longing for the day when you and bae can pose for an Instagram next to the SOLD sign in the yard, today I’m going to encourage you to consider this decision a little differently.
This is especially poignant for people in their 20s who feel like they need to at least think about buying to be considered Successful Young Adults™, but can't imagine it becoming a reality without fancy financing. Well, my friends, shrug off that pressure and read on.
After all, it’s just math.
Ew, math. Right? Wrong! Math is sexy when it makes you rich!
Of course, I’m talking about the 1% rule.
In essence, the 1% rule functions on two sides of the same coin.
As an owner…
If you can rent out your real estate for at least 1% of its total value, it’s (generally) considered a good investment.
I was never fantastic in math class and loved a good example, so here we go.
Someone who owns a home valued at $200,000 would need to charge at least $2,000 in rent monthly to indicate profit.
As a renter…
If you’re paying rent that’s 1% or more the value of a home you could afford, you should consider buying.
So let’s say you’re (comfortably) paying $2,500 in rent (which—if this is you—why are you reading my blog? YOU should be blogging about how you afford $2,500 in rent! TEACH US!). That means you could “afford” (a relative term, I’m learning) something priced at $250,000 or lower, assuming your current residence is indicative of how the market works in your area.
But not so fast...
Like I said, it’s math.
If your rent is $897 per month like mine, it means the equivalent in purchasing would be a home that’s $89,700—a laughably low price for an area like Dallas with Texas-sized appreciation. But if I were paying $897 a month in a market where there were loads of $90,000 homes sitting around, I'd consider buying!
(Side note, a quote I heard in one of the podcasts listed below: Buying in a hot market is generally a poor plan since it usually means the majority of the appreciation has already happened.)
The good news about the 1% rule is that it doesn’t rely on appreciation in order to work—sure, appreciation is great, but it doesn’t have to happen in order for your investment to be considered fiscally sound.
Because hey, real estate (like anything) can become a bad investment if things don't go your way.
That surprised me while I was researching for this post. The average number varied a little bit (keep in mind, we’re talking nationally—not in anomaly markets like New York, San Francisco, etc.), but the average 10-year rate of return on residential real estate that I found most was between 6 and 7.5%.
The average 10-year rate of return for the stock market was between 8 and 10%.
Of course, these numbers are based on the past and don't predict the future. But they're a good place to start for argument's sake.
While nothing’s ever a guarantee (both the stock market and housing market are infamously volatile and inherently unpredictable environments), it’s not impossible that your money will go further in diversified index funds than in a home right now, especially if you can't afford to put 20% down.
I want to include a little background on this 'money down' business, in case this is extremely foreign to you. I never understood or looked into any of this before I was interested in buying, so it stands to reason that others my age may not really know either. And if you do know, don't be an ass. Just come along for the ride and enjoy my beautiful Google examples!
When you buy property, you have to put down a 'down payment.' The rest of the cost is a loan from the bank, which you pay over time—that's your mortgage. There are different types of mortgages with different interest rates, but some lenders will allow you to put as little as 3% down (to entice new buyers).
While low down payments make home ownership more accessible, it means you're paying off more of the home's value in a mortgage--with interest.
If your eyes just glossed over, stick with me.
Back on my example grind, let's use a mortgage calculator to illustrate:
20% down on a $250,000 home
Your monthly mortgage payments would be $955. In total, you'd owe $343,739 on your $250,000 home (plus your $50,000 down payment).
This doesn't take into account property taxes or HOA fees, which are high in some areas and can tack on another several hundred dollars per month.
Initially on my condo hunt, I saw those $955 monthly payments and was like... holy shit, I can TOTALLY afford that! Unfortunately, that's not the whole story. When all the other fees and taxes were factored in, those monthly payments often crept up over $1,500.
3% down on a $250,000 home
In this scenario, you owe the bank $242,500.
Your monthly payment on that loan is $1,158 (rather than $955) and the total you owe on your $250,000 home is $416,784.
So while the down payment is way more accessible, you're paying close to $200 more per month and owe $73,045 more in interest.
What's right for YOU is your decision, and if you're OK with paying more over time for something in order to have it now, then that's entirely your financial decision.
However, if you're able to sock your money away to grow in diversified index funds until you have enough to make a 20% (or more!) down payment, you'll spend substantially less in the long run.
While home ownership is emotionally appealing, it's sometimes more lucrative to invest in the stock market instead of the real estate market. It's just math, and real estate is just an investment vehicle—use the 1% rule to determine your best bet.
My research & Recommended Reading
The young woman's money guide for all the things you're too embarrassed to ask your friends. Build the life you thought you were too broke to afford through managing your spending habits, travel hacking, and simple, smart investing.
Full-time Brand marketer at Southwest Airlines, part-time Yoga Sculpt teacher, occasional Waffle House Model and reformed materialist.
Download my free budget tool
Rent or buy calculator
Invest with Robinhood. Get free stock.
The fine print: