HOME EQUITY AND THE FIVE-YEAR RULE
Written by Blanche Evans
When you buy a home, you should plan on staying in your home at least five years. Why? You'll need equity in order to sell the home without bringing cash to the closing table.
Equity means ownership. Building equity takes time, usually about five years for typical households to be able to sell at a profit, break-even, or without losing money.
This five-year rule can change depending on what state you live in, how much you put down to reduce the size of your loan, and how healthy the housing market is in your area. In some states, you could pay as much as 14% in closing costs and fees to buy and sell a home.
These include the fees to close your original loan, Realtor fees when you sell, title and/or abstract company fees, attorneys fees, surveys, home inspections, and so on.
Building equity can be challenging. With any mortgage loan, you'll find that the first five years' worth of payments go more toward paying interest to the lender than reducing your principal obligation.
That said, there are four ways you can build enough equity so you can sell at break-even or better:
1. Put more money down. If you put 20 percent down, you're covered. If you put down 3.5, 5, or 10 percent, you'll have a little equity, but not enough to sell your home anytime soon.
2. Pay your mortgage on time and in full. Some of your principal will be reduced along with interest. The longer you pay, the more principal you'll reduce.
3. Make additional payments toward reducing your principal. You can add an extra $50, $100 a month, $500 or whatever you want as extra payment.
4. Let the housing market raise the value of your home. The housing market typically rises one to two percentage points above inflation annually, but for nearly a decade, the market has been volatile. Many homes gained and lost significant value. As the market stabilized, home prices have risen again, replacing lost equity and adding more value in most markets.
Putting money into your home is the most reliable way to build equity. Equity gives you freedom to sell whenever you want. If you don't have much equity, you're better off following the five-year rule before you sell.