Why the 5-year home sale rule still makes sense (most of the time)
BY NATALIE CAMPISI BANKRATE.COM
NOVEMBER 29, 2018 03:00 AM,
UPDATED NOVEMBER 29, 2018 02:49 PM
Some things get more valuable with age, like fine wines and real estate. The longer you keep them, the more valuable they get.
In real estate, this calls to mind the five-year rule, which states that new homeowners should generally stay put for at least five years before selling their property or risk losing money.
The reason for this rule is that closing costs and real estate commissions required to buy and sell will consume 7 to 15 percent of the cost of the house. Your home will have to appreciate up to the costs of buying and selling just to break even. If you want to make money, then the value must exceed those fees.
Because real estate usually appreciates slowly and values aren't an exact science, the longer you keep the house the more money you stand to make.
"You can't guess how much a market is going to appreciate," says Tom Forker, SVP and market manager at Bryn Mawr Trust. "But generally 2 percent per year is an OK market, and 3 to 4 percent is a hot market."
While there are people who get lucky, it's not the norm to see huge annual spikes in appreciation – especially significant enough to negate the transaction costs discussed above.
Most people understand making money off real estate is a long game, says Richard Green, chair of the USC Lusk Center for Real Estate. "You'd have to be lucky to make 3 percent per year. If you go out to 10 years, then the amount of appreciation you need to cover your costs drops to about 1.5 percent (annually) and that's more reasonable. If you go to one or two years, then you're looking at an appreciation of 5 to 7 percent per year and that's just not going to happen," Green says.
Buying and selling costs can crush you
When budgeting for a home, it's important to factor in closing costs. This is especially true for people who don't plan on staying longer than a couple of years. Closing costs are expensive and you'll want to get that money back when you sell your home.
Closing costs include fees from lawyer's expenses to title search charges and lender's costs. Some of these fees are negotiable (lender's costs) but most are set in stone. You might be able to get the seller to pay for some of these expenses, but this is not typical and you shouldn't count on it – although it might not hurt to ask.
The average closing costs range from 2 to 5 percent of the cost of the house and depend on the taxes in your area and the size of your mortgage. That means closing costs on a $250,000 home can be $5,000 to $12,500.
Selling a house is often more expensive than buying one. The real estate agents' commission alone can suck up 4 to 6 percent of the home's sale price. So if you sell your house for $250,000 then you'll pay up to $15,000 in commissions.
If you move out before you sell, you'll continue to pay taxes and your mortgage plus keep the water and electricity on for real estate showings, expenses that erode your profits. You'll also want to check your mortgage to see if it has a prepayment penalty. These are not as common as they once were, but they still exist. Basically, these are penalties assessed to mortgages paid off before a certain time frame, usually between 1 and 5 years.
Nobody seems to understand the five-year rule better than investing guru Warren Buffett. Buffett is almost as famous for living in the same Omaha, Nebraska, house he purchased in 1958, as he is for being one of the wealthiest men in the world. The CEO and chairman of Berkshire Hathaway bought his 5-bedroom house for $31,500. Today, the property is valued at $652,619. That's about $10,400 per year, or a total of $624,000 in equity. Subtract even the highest fee estimate and Buffett still ends up way ahead, not that he's needing the cash.
Homeowners who want to move, but aren't ready sell
For folks who need to move before they've built up an enough equity to cover the fees, renting out their home can be a good option, says Alexander Sifakis, president of JWB Real Estate.
Generally, homeowners can cover their mortgage payments with rental income.
"If you're buying the right home in the right area, then you should be able to rent it out and at least break even on it. If mobility is a big concern of yours or the market has slowed down, you can still rent the property out and continue to build equity," Sifakis says.
Cities like Orlando, Las Vegas and Knoxville are seeing rent prices rise quickly, while Arizona took the prize for the state with the fastest-growing rent at 2.6 percent year over year, according to data from ApartmentList.
Homes in vacation-worthy locations, like on the beach or near popular tourist attractions, can also be rented out via platforms like AirBnB. Before listing your home, however, homeowners should educate themselves on local laws governing these kinds of rentals.
For example, some cities limit or even forbid short-term rentals. You might also be required to get a permit or license before you can host paying guests, depending on where your property is located.
After all is said and done, buying and selling a house is a costly endeavor. This is why it's so important for homebuyers to consider where they want to be in the next five to 10 years before they lock themselves into a mortgage. If you don't plan on being in the house for more than five years, then you should seriously consider renting or, if you're in a strong market, renting your property and letting the value tick up while you move to a new location.
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