Making home equity work for you

By Bankrate.com

If you're like most Americans, your home is your most valuable asset, and your mortgage payment is almost certainly your largest monthly payment. With so much money tied up in one item, it's important to have a plan in place for using your home to reach your financial goals and to understand the role your home plays in your overall financial picture.

Is it smart to take out a home-equity loan for home improvements? Is it wise to tap equity for higher-education expenses? Should you scrimp to make extra payments to principal each month?

• Calculator: Estimate your home equity

How you treat your home's equity depends on your particular financial situation, says Carmen Petote, a certified financial planner at Allegiance Financial Advisors in Pittsburgh. Here, Petote takes a look at possible uses of home equity:

Heading to retirement

"Get all debt paid off by retirement," Petote says. "The less debt, the more control you have over your finances and decisions."

Though not everyone has that goal for their mortgage, as a homeowner any equity you have in your home is similar to money in the bank and can only help you when you retire. That said, there are three things to think about before funneling money into your home:

Pay down highest interest rates first. While it's important to look for the highest rate of return when investing, when repaying debt work to eliminate your highest rates first.

Fully fund 401(k)s. Always take advantage of employer matching contributions. Petote recommends maxing out your retirement plan before funneling extra money into building home equity. Matching funds are essentially free money, and Petote advises putting as much money away as possible.

"Even if your employer matches (only) 25%, that's better than I can do even on my best day," he says. "And it probably exceeds the return you would receive on your home."

Defer prioritizing home equity if home values are depreciating. When the housing market in your area is sliding, Petote suggests investing in higher-return portfolio investments first. Many people count on the equity in their home to help sustain them in retirement, but a house is not always the high-yield investment it first appears to be. Petote advises checking the annual return. Let's say you look at your house after 20 years and see that it's tripled in value, you might think that type of equity growth will continue.

• Video: Rethinking home equity

"That's deceiving," Petote says. "If you look at annualized return, it's probably in the 2(%) to 4% range." He says it's best to invest wisely with a professional than "just sinking the money into your house." Invest in the house after maxing out your retirement plan, when putting money into the house becomes a debt-reduction issue.

Building home equity

Looking forward to the mortgage-burning party but finding it tough to set aside extra funds? Petote suggests some strategies to pay off your mortgage faster and to build home equity:

• Set aside a portion or the full amount of any raise you receive for mortgage or equity loans.

• Send an extra payment to your lender at the beginning of the month.

• Apply any money left in your checking account at the end of month to the loan's principal.

• If you've been paying down a credit card, shift the money to your mortgage payment after you pay off your cards; you're already used to paying out that money anyway.

Need a loan?

If you know you need to borrow, weighing net rates of return will help you decide the smartest source. "If you have to go get money somewhere, home equity is usually the best place," Petote says.

Continued: Weigh your options

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