What Is the 5-Year Home Sale Rule?
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When you’re deciding whether to rent or buy a home, multiple factors should be considered. Homeownership is both a lifestyle choice and a major financial decision. One of the key questions to ask yourself is how long you plan you stay in the home. Financial experts frequently suggest that, if you plan to buy, you should probably plan on keeping the property for at least five years before selling.
The 5-year rule, explained
The five-year rule isn’t a rule by traditional definition. You won’t receive a punishment if you break this rule, although there’s a chance you could lose some money. The “rule” is in place to provide a warning to buyers that the cost to buy and sell a property must be factored into the equation of your purchase price and sales price.
For example, if you buy your home for $250,000 and sell it a few years later for $260,000, that doesn’t mean your profit is $10,000. In fact, you may lose money in this transaction.
“You need to budget 7% to 8% of your sales price for sales costs, including things like commissions to real estate agents, real estate transfer taxes and fees for document preparations,” said Morgan Knull, an associate broker with Re/Max Gateway in the Washington, D.C. area. “To offset those costs, you need the value of your property to have increased since your bought the property, or you need to have built up equity by paying down your mortgage balance.”
The average real estate commission paid for a home sale ranges between 5% and 6%, although commissions are negotiable.
As you can see, to have a clear picture of your profits when you sell, you’ll need to know what you spent to purchase your home, as well as what it will cost to sell. So while your purchase price may have been $250,000, your total cost to buy was higher.
When you buy your home, you’ll typically make a down payment and pay closing costs that could add up to thousands of dollars. While closing costs vary by location, you’re likely to pay between 3% and 6% of the sales price, or $7,500 to $15,000 on a $250,000 home.
The next piece of the calculation looks at the potential value of your home when you’re ready to sell, as well as the balance owed on your mortgage.
Home price appreciation varies by location, but U.S. home prices have risen around 6% annually since the 2007-2008 financial crisis. While it can be difficult to know for certain what your home will be worth when you’re ready to sell, determining your mortgage balance is simpler. You can check a loan amortization schedule that tells you how much you’ll pay in principal and interest each month, and shows your loan balance for every month until it’s fully paid.
For example, if you buy a $250,000 house and make a 5% down payment of $12,500, your initial loan balance will be $237,500. If you choose a 30-year fixed-rate mortgage at 5%, your monthly principal and interest payments will be $1,186. But keep in mind that, during the initial years of your mortgage, you pay more in interest than in principal.
If you need to sell your home in two years, your mortgage balance will be $229,491. In five years, the remaining loan balance will be $216,087. In 10 years, it will be $189,449.
As you can see, waiting a few more years to sell means you owe less on your loan and your home is more likely to increase in value. Those two factors mean you have more of a chance to recoup your purchase costs and perhaps some cash for a down payment on your next home.
“Even if the housing market isn’t doing well in your area, inflation naturally increases home values over time,” Knull said. “Paying your mortgage for years is a forced savings plan that gives you more equity.”
The amount you owe can impact how much cash you get back after you sell. For example, if you’ve paid $50,000 on your $250,000 loan and sell it for $260,000, you’ll keep $39,200 after your 8% ($20,800) in closing costs and your remaining loan balance of $200,000 are paid. In that same loan scenario, if you paid $25,000 on your loan, your cash at the end of the sale would be $14,200.
Homeowners typically stay in their home 10 years before selling, according to the National Association of Realtors 2018 Home Buyer and Seller Generational Trends Report.
How to avoid breaking the 5-year rule
While it’s best to plan to stay in your property at least five years, it’s not always possible.
“You may get married or get divorced or have kids in those five years, which means you could need to move,” Knull said. “You could lose your job, or get a really great job offer someplace else.”
If you’re uncertain of your plans, it may make sense to rent until you’re more sure of the stability of your job, your relationships or your commitment to a specific neighborhood. Renting provides flexibility, especially if you’re on a month-to-month lease. But keep in mind that rents have been increasing in many locations, too, so you’d be wise to compare rates with a tool like LendingTree’s rent-versus-buy calculator.
While renting may be the best option, there are other ways to reduce your chance of losses from an early sale:
Make a bigger down payment. The size of your down payment can impact the money you need to come up with if you have to sell before you’ve owned your home for five years, said Knull.
“If your down payment was zero or 3%, you could be in a precarious situation if you have to sell sooner than expected,” Knull said. “If home values haven’t risen fast enough and you haven’t paid down much of your balance, you could need to bring money to the closing table.”
Even people who had to sell their homes in the middle of the recession usually didn’t owe money if they had made a bigger down payment because that meant they had a bigger cushion in their home, Knull noted.
“There’s a reason the 20% down payment used to be the gold standard, because at least people don’t have to come up with money if they have to sell it early,” he said. “Of course, the money you spent on your down payment was gone as soon as you bought the house, but if you can get over the idea of having to make that money back, you can at least be happy that you don’t have to bring money to the table.”
Pay extra on your mortgage. If you can afford it, pay more on your mortgage each month or make a lump-sum payment each year to reduce your balance. You can use a tool like LendingTree’s mortgage calculator to see how much of a difference extra payments can make. The reduced loan balance means you’re more likely to walk away with some cash in your pocket, even if you must sell before five years.
Buy in an appreciating neighborhood. Choosing a home in a neighborhood where homes are rapidly becoming more valuable instead of one with stable values could mean an early move will still provide you with a profit, Knull said.
Avoid new construction. If you have to sell a newly built home after just a year or two, you’re likely to be competing with brand-new homes that are still being constructed, noted Knull. Buyers are less likely to pay full price for your house when they can get a new one with more potential options, he added.
Become a landlord. Even if you have to move, that doesn’t mean you must sell your house. Depending on the rental market in your area, you could potentially rent the property and use that income to continue to pay your mortgage. You’ll need to estimate whether the rent will cover your mortgage and maintenance costs, Knull said. If you’re leaving the area, you may want to hire a property management company to take on landlord responsibilities for you, which often costs 7% to 10% of the monthly rent.
Offer a short sale. If you’d rather sell the house but you owe more than it’s worth, Knull said you may be able to negotiate a short sale with your lender, which means convincing the lender to accept less than your full loan balance in exchange for the house. However, a short sale could have tax implications and will damage your credit, so it’s best to consult a housing counselor before choosing that option.
The bottom line
The five-year home sale rule can be a good guideline to help you make the decision about whether you’re ready to buy or should continue to rent. If you’re emotionally ready to become a homeowner, you should look ahead five years and evaluate your chances of living in the same location. But life is full of unknowns, so it’s smart to prepare yourself with some options in case you must move before the five-year mark.