How to Use Home Equity Wisely

According to a survey by the financial website Bankrate.com, 4 percent of homeowners estimate they owe more on their mortgages than their home would bring if sold. The rest of the surveyed homeowners have equity in their homes. Given the decline in housing prices from 2006-2012, however, many homeowners have less equity than they did before the market crash. Because home equity is an asset, even when it is shrinking in value, it pays to do everything in your power to use it wisely by making good financial decisions to preserve equity.

Create a financial plan that outlines your goals for your money. Determine where you want to be in one year, five years and over a longer time frame. You might find that your plan allows you to continue paying on your home, leaving your home equity intact and even increasing it by not having to borrow from it. This is arguably the best course of action, as you can continue to build your net worth by retaining and increasing your home equity.

Determine whether borrowing from the equity in your home will be necessary. If it is, you will want to shop around for the best deal on either a home equity loan or a home equity line of credit. The line of credit is used as you need it and generally will have a fixed time to use the line, as well as a fixed time to pay it back. For example, you might have five years to use the line of credit. During that five years, you pay interest on the amount that is outstanding. At the end of the use period, the amount outstanding converts to an amortizing loan, and you pay it off over a specific term. A home equity loan is more conventional, as you borrow a fixed sum of money and pay it back over a specific term.

Choose a reverse mortgage if you are at retirement age, generally over 62, and need to tap into your equity for living expenses. With a regular mortgage, the lender advances the amount of the mortgage, and you pay back the principal and interest each month. With a reverse mortgage, the lender pays you a sum each month, and you generally don't pay it back until you die, sell or move out of the home. However, these loans can have significant financial implications, so it makes sense to talk to a financial adviser to review all options before taking out a reverse mortgage.