For most people, buying a home is the single largest investment that they’ll ever make. However, it’s not the value of their home that adds to their worth – it’s the equity they’ve built up in it. In fact, the ability to build wealth through home equity is one of the best reasons to buy rather than rent.
When it comes to building home equity, there’s a lot of talk about the 5-year rule: it takes five years of living in a home to recoup your upfront costs and truly begin establishing equity. But in today’s real estate environment, is the 5-year rule even still relevant? Let’s take a closer look.
Key Takeaways
- Home equity is the difference between your property’s value and your total mortgage debt.
- The 5-year rule states that you need to stay in your home for at least 5 years to really start seeing equity growth.
- Other methods to build equity, such as paying extra on your mortgage and refinancing into a shorter loan term, can help you build equity faster.
What It Means to Build Home Equity
Building home equity is the process of increasing your monetary ownership stake in your property. Simply put, home equity is the difference between your home’s value and the amount you owe on your mortgage.
For example, if your home is valued at $400,000 and you owe $250,000 on your mortgage, your current home equity is $150,000.
You can build home equity in two primary ways: the value of your home increasing and the balance of your mortgage decreasing.
Despite the high cost – and oftentimes necessary financial sacrifice – of buying a home, this potential for equity growth makes homeownership worthwhile because building equity increases your net worth and improves your overall financial position and flexibility.
How Long Does It Take to Build Equity?
As we touched on at the beginning, experts have long recommended you plan to stay in your home at least 5 years to really begin building equity.
However, the real estate market has changed drastically over the past decade: according to the Federal Reserve Bank of St. Louis, home values increased rapidly in the early 2020s but have now slowed their growth or even dropped in some markets.
| Average US Home Sales Prices Over Time | |
| 2015 – Q2 | $339,700 |
| 2016 – Q2 | $357,900 |
| 2017 – Q2 | $376,900 |
| 2018 – Q2 | $378,400 |
| 2019 – Q2 | $376,700 |
| 2020 – Q2 | $371,100 |
| 2021 – Q2 | $428,600 |
| 2022 – Q2 | $525,100 |
| 2023 – Q2 | $503,000 |
| 2024 – Q2 | $502,200 |
| 2025 – Q2 | $512,800 |
At the same time, interest rates have risen from their pandemic-era lows, although they have since retreated from their late 2023 peak.
Given these relatively recent changes, is the 5-year rule still relevant? For most homeowners, yes, it is.
That may not hold true for everyone, however. In some cases, it may take more than five years to really begin amassing equity. Other times, you may be able to build home equity much faster. While it is often nice to have more equity when you refinance your mortgage, some lenders and loan types do have a strict equity threshold required to refinance. We’ll cover some tactics for doing so a little further down.
How Mortgage Amortization Shapes Home Equity
One of the most significant factors that affects home equity growth is mortgage amortization – the process by which a loan with consistent monthly payments is paid off over time. Amortization is a key reason it can take 5 years of homeownership before you truly begin seeing equity growth.
Since an overwhelming majority of the payments go toward interest early in a mortgage’s repayment schedule, only a small portion is used to reduce the loan’s principal balance.
As the loan matures, the percentage of the payments applied to principal gradually increases.
For example, let’s take a look at the principal and interest distribution over time for a $400,000 30-year mortgage at 6% interest with monthly payments of $2,398:
| Month | Principal | Interest |
| 1 | $398 | $2,000 |
| 9 | $414 | $1,984 |
| 19 | $436 | $1,963 |
| 29 | $458 | $1,940 |
| 39 | $481 | $1,917 |
| 49 | $506 | $1,892 |
| 59 | $532 | $1,866 |
| 69 | $559 | $1,839 |
| 79 | $588 | $1,811 |
| 89 | $618 | $1,781 |
| 99 | $649 | $1,749 |
| 109 | $682 | $1,716 |
| 119 | $717 | $1,681 |
| 129 | $754 | $1,644 |
| 139 | $793 | $1,606 |
| 149 | $833 | $1,565 |
| 159 | $876 | $1,523 |
| 169 | $920 | $1,478 |
| 179 | $968 | $1,431 |
| 189 | $1,017 | $1,381 |
| 199 | $1,069 | $1,329 |
| 209 | $1,124 | $1,275 |
| 219 | $1,181 | $1,217 |
| 229 | $1,242 | $1,157 |
| 239 | $1,305 | $1,093 |
| 249 | $1,372 | $1,026 |
| 259 | $1,442 | $956 |
| 269 | $1,516 | $883 |
| 279 | $1,593 | $805 |
| 289 | $1,675 | $724 |
| 299 | $1,760 | $638 |
| 309 | $1,850 | $548 |
| 319 | $1,945 | $453 |
| 329 | $2,044 | $354 |
| 339 | $2,149 | $249 |
| 349 | $2,259 | $139 |
| 359 | $2,374 | $24 |
Because of mortgage amortization, the longer you stay in your home – and retain your original mortgage – the more equity you begin to build.
Can Home Equity Decline?
Yes, your home equity can decline. While home values typically appreciate over time, they may fall under certain conditions. Since home equity is your home’s value minus your mortgage debt, a drop in value will cause your equity stake to decrease.
In some cases, your home’s value may even drop below the amount you owe on your mortgage – especially within the first few years. This can lead to negative home equity, also known as being underwater on your loan.
Another way your home’s equity can decline is by borrowing against it. This type of decrease, however, doesn’t inherently affect your overall net worth since you’re simply converting your built-up equity into cash.
Building Home Equity as a Prospective Homebuyer
As a prospective homebuyer, you can take several steps to help establish a greater amount of home equity from the very onset.
Time Your Home Purchase
Home appreciation is not linear. Like most other forms of investments, real estate markets function in cycles. By timing your home purchase when property values are rising, you can benefit from faster appreciation in the first few years.
Conversely, avoiding purchasing when local home prices are decreasing can help prevent you from winding up underwater on your loan.
Keep in mind, however, that this isn’t necessarily a reliable way to build equity, as market cycles are out of your control and can switch directions at any time.
Make a Larger Down Payment
While it’s possible to buy a home with as little as 3% down (or even 0% down with certain loan types), the larger your down payment, the more equity you start with.
That’s because your down payment directly converts into home equity. For example, if you put $12,000 (3%) down on a $400,000 home and finance the other $388,000, you’ll begin with $12,000 equity. Putting $40,000 (10%) down would mean financing only $360,000, with that down payment translating dollar-for-dollar into $40,000 in equity.
Don’t Finance Closing Costs
When buying a home, you’re responsible for closing costs, which typically range from 2% to 6% of the purchase price. How those costs are covered can affect how quickly you build equity.
In general, the more of your upfront costs that are paid outside of the loan balance, whether through savings, seller concessions, or down payment assistance programs, the more equity you start with on day one. Rolling closing costs into your loan increases the amount you borrow, which means you’ll pay interest on those costs over time and may build equity more slowly.
Purchase a Fixer-Upper and Build Sweat Equity
One of the best ways to quickly build equity early on in homeownership is to purchase a fixer-upper and make improvements that increase its value through sweat equity, which is the process of a homeowner adding value to their property by renovating it themselves, without relying on outside contractors or professionals.
Keep in mind that this approach is not for everyone, as it requires the time and skills to make quality, long-lasting improvements. Those with the capability, however, may be able to use sweat equity to rapidly increase their home’s value.
Speeding Up Home Equity as an Existing Homeowner
If you already own your home and want to speed up equity growth, here are a few proactive steps.
Make Extra Payments on the Loan Principal
We covered how your monthly mortgage payments primarily go toward interest costs early on in your loan. However, you have the right to make extra payments and have them applied to your principal balance, thus reducing the amount you owe and increasing your equity stake.
Plus, making extra payments in the first few years of homeownership can shorten the length of time you pay on your home and reduce the overall amount of lifetime interest you incur.
Make Value-Adding Improvements
Similar to buying a fixer-upper, you can make improvements to your existing home that increase its value and build equity faster.
However, not all improvements provide the same return. In most cases, you’ll likely spend more on renovations than you’ll recoup in increased value.
That’s why, by and large, this method shouldn’t be used solely to grow equity. Instead, you should focus on improvements that make the home better suited to your needs, with the increased equity seen as a bonus.
For example, the Journal of Light Construction reports that adding solar power to your home will only result in its value increasing by 30% of the amount you spent. However, this doesn’t account for any energy savings you may experience. Adding a wood deck, on the other hand, could provide a 95% return on investment.
Refinance to a Shorter Loan Term
One powerful way to build home equity faster is to refinance your existing mortgage into a shorter-term loan. The shorter your mortgage term, the larger the percentage of your payment that gets applied toward principal.
To put it in perspective, here’s what the principal and interest distribution would look like on a 15-year mortgage using our previous example of a $400,000 loan financed at 6% interest:
| Month | Principal | Interest |
| 1 | $1,375 | $2,000 |
| 9 | $1,431 | $1,944 |
| 19 | $1,505 | $1,871 |
| 29 | $1,582 | $1,794 |
| 39 | $1,662 | $1,713 |
| 49 | $1,747 | $1,628 |
| 59 | $1,837 | $1,539 |
| 69 | $1,931 | $1,445 |
| 79 | $2,030 | $1,346 |
| 89 | $2,133 | $1,242 |
| 99 | $2,242 | $1,133 |
| 109 | $2,357 | $1,018 |
| 119 | $2,478 | $898 |
| 129 | $2,604 | $771 |
| 139 | $2,738 | $638 |
| 149 | $2,878 | $498 |
| 159 | $3,025 | $351 |
| 169 | $3,179 | $196 |
| 179 | $3,342 | $34 |
Keep in mind, however, that because of the shorter term, your monthly payments will be larger. In this example, the payments on a 15-year loan would be $3,375 compared to $2,398 on a comparable 30-year mortgage.
Note: While we used a constant 6% interest rate for this comparison, loans with shorter terms tend to come with lower interest rates. As such, the actual spread between the two different payments would be smaller, and you’d save even more in lifetime interest costs.
Why You May Not Want to Speed Up Equity Growth
Even though increasing your home equity helps build wealth, accelerating equity growth beyond organic appreciation and standard mortgage paydowns typically comes at a cost to you. As such, there may be scenarios where trying to build equity faster isn’t the best strategy.
- Investment Opportunity Cost: In some cases, you improve your overall financial situation more by taking the funds you’d use to build equity and investing them elsewhere where you can earn a rate of return higher than the interest rate you pay on your mortgage.
- High-Interest Debt: If you have high-interest debt – such as credit cards – you should focus on paying them off first. Eliminating this debt frees up funds in your budget to pay down your mortgage faster later on.
- Liquidity Needs: Home equity isn’t liquid. While there are methods for tapping into your home equity – which we’ll cover shortly – if you are concerned about needing immediate access to your funds, you’d be better off storing your money elsewhere than in home equity.
- Tax Considerations: The interest you pay on your home loan is generally tax-deductible, as long as you itemize your tax deductions. Depending on your individual tax situation, it may make more sense to keep your mortgage for its full term rather than pay it off sooner.
Tapping Home Equity
So, how does home equity actually benefit you? The simplest way is that your home equity will be returned to you as cash when you eventually sell your home.
For example, say you have a $400,000 home with a $150,000 mortgage and $250,000 in home equity. Upon its sale, the funds will first be used to pay off your mortgage, and the remaining $250,000 will be transferred to you after closing.
However, there are ways to tap into your built-up equity without selling your home. This is most commonly accomplished through three types of loans:
- Cash-Out Refinance: A cash-out refinance replaces your existing loan with a larger one, with the difference returned to you as a lump sum.
- Home Equity Loan: A home equity loan is a second mortgage that lets you access your home equity as a lump sum of cash without replacing your existing loan.
- Home Equity Line of Credit (HELOC): HELOCs are another second mortgage that keeps your existing loan intact while providing ongoing access to a revolving line of credit.
Although you can use the funds you receive from tapping home equity for any purpose you choose, the best use is something that helps to improve your overall financial situation, such as:
- Consolidating debt
- Remodeling your home
- Funding a business venture
- Purchasing additional real estate
The Bottom Line
Home equity is a powerful tool for building long-term wealth. Your home equity grows when either your home’s value increases or your mortgage balance decreases.
Most homeowners want to abide by the 5-year rule and plan to stay in their home for at least five years to start seeing noticeable equity growth. However, you can take numerous steps – such as paying down your principal balance or refinancing into a shorter-term loan – that can help you build equity sooner.
Ready to see how refinancing could help speed up your equity growth? Begin your application with Refi.com today!
