- Home equity loans for business offer a few advantages over traditional business loans.
- Interest rates are low, and the process can be much faster.
- However, home equity loans for business put your home at risk if you cannot afford the payments.
Table of Contents
- What is a home equity loan?
- Can a home equity loan be used for a small business?
- Pros of using a home equity loan for business
- Cons of using a home equity loan for business
- How a small business owner can qualify for a home equity loan
- Alternatives to using a home equity loan for your small business
- Is it good to use a home equity loan for your business?
Do you run a small business, or are you interested in launching one? It can be difficult to fund a business startup or keep it going without the proper financial resources. Fortunately, there are financing options business owners can pursue, including a home equity loan for business.
Find out more about how a home equity loan (HEL) works, the advantages and disadvantages of a home equity loan, home equity lenders to consider, alternatives such as a small business loan, and more.
What is a home equity loan?
A home equity loan is a type of loan that enables homeowners to borrow against the equity they have accrued in their homes. Equity is the difference between a home’s current market value and the amount still owed on the mortgage.
If you qualify for a HEL, you can borrow up to 80% to 85% of the value of your home, minus any outstanding mortgage debt. This loan is secured via your home’s equity. That means if you cannot make your home equity loan payments and default on the loan, the lender can foreclose on your property to recoup their losses.
“Home equity loans typically have fixed interest rates, meaning that the interest rate will not change over the life of the loan. This can make budgeting easier for borrowers, as they will know exactly how much their monthly payments will be,” says Joshua Haley, founder of MovingAstute.com in New York City.
Can a home equity loan be used for a small business?
The funds received from a home equity loan can be used for almost anything, such as to pay for home improvements, college tuition, a significant event like a wedding, or a second home purchase. You can also use a home equity loan for small business purposes, provided the lender allows it.
Dennis Shirshikov, a strategist for Awning.com and a professor of economics and finance at City University of New York, notes that some home equity lenders may place specific restrictions on using home equity loan funds for business purposes. That’s why it’s best to inquire with a HEL lender and be transparent about what you plan to use the funds for before applying.
Pros of using a home equity loan for business
There are several reasons why you may want to apply for a home equity loan if you are running a small business or planning to create one soon.
“Home equity loans are relatively easy to apply for,” says Shaun Martin, owner/CEO of We Pay Cash For Houses. “The interest rate charged is also less than charged for some other types of loans. Home equity loans typically charge around 6% to 7% interest with good credit. And payment periods are flexible.”
In fact, you can choose a home equity loan term as short as five years or as long as 30 years, depending on the lender.
Because home equity loans charge a fixed rate of interest, you’ll know exactly how much you’ll be paying back each month, which provides peace of mind.
“Some common uses for a home equity loan by a small business owner include using the funds to purchase inventory or equipment, renovate or expand the business premises, hire additional staff, and run advertising and market campaigns,” notes Haley.
Shad Elia, founder/CEO of New England Home Buyers in Massachusetts, says you can use HEL funds as a source of capital for a startup company.
“It’s common practice for homeowners to use their home equity as a down payment or as the entire purchase price for an investment property they will use to run a business, for example,” Elia adds.
Another perk of pursuing a home equity loan for business purposes? The interest on a HEL is often tax-deductible.
“And because you can use the equity in your home as collateral, it may help you qualify for a larger loan amount than you could get elsewhere,” Haley explains.
Cons of using a home equity loan for business
Make no mistake: When you take out a home equity loan, you are putting your primary residence at possible risk. That’s because you must use your home as collateral for the loan.
“The lender may foreclose on your home if your business fails or you have financial difficulties and cannot repay the debt. This will also significantly lower your credit score, making it more difficult for you to get future loans,” cautions Elia.
“There may be additional documentation required to qualify for a home equity loan as a small business owner, too,” warns Haley.
There are tax and legal risks involved with funneling home equity loan proceeds into a business, as well.
“You can pierce the corporate veil between business and personal property. Once you use personal funds for business or vice versa, you become personally liable for business debts and lose the protection many corporate structures offer,” says Shirshikov.
How a small business owner can qualify for a home equity loan
To be eligible for a home equity loan for business, you commonly need at least 20% equity accrued in your home. You must also demonstrate sufficient earnings and an acceptable debt-to-income ratio.
“You must provide proof of income and ability to repay the loan. Borrowers will typically require your tax returns, bank statements, and other financial documents to demonstrate this. And a minimum credit score is needed. Most lenders require at least a 620 to 640 credit score to qualify for a HEL,” Haley continues.
Michael Lederman, co-founder of Clara Capital, notes that it can take up to 45 days to receive funding on a home equity loan.
Alternatives to using a home equity loan for your small business
You aren’t limited to using a home equity loan for business purposes. Instead, think about these other financing options:
- A small business loan provided by the U.S. Small Business Administration (SBA) or various lenders and banks
- An SBA limited grant, awarded to some small businesses that specialize in things like scientific research and development
- A home equity line of credit (HELOC), a type of loan with a variable interest rate in which you use your home’s equity as collateral in exchange for obtaining a revolving line of credit from a lender. You can borrow against this line as needed and repay your balance.
- A personal loan, which can be easy to qualify for but often charges higher interest rates.
“Another option is a short-term business line of credit. This provides easier access to capital for entrepreneurs with less-than-perfect credit. Some banks will only require a soft credit pull and three months of business bank statements. Depending on the bank, funding can happen within 24 to 48 hours, too,” says Lederman.
Is it good to use a home equity loan for your business?
So long as your lender approves of you using your home equity loan funds for business purposes (meaning they have no such restrictions in place), applying for a home equity loan for business purposes can make smart financial sense – especially if you cannot find a more affordable means of business financing or you don’t qualify for other options.
“I believe it can be a good idea to use a home equity loan for a small business. But there are many things to consider before doing so,” Haley says. “For one, it’s important to ensure you are actually using the loan for your business and not just borrowing money to cover personal expenses. You’ll also want to make sure you have a solid plan for how you will repay the loan and that your business is actually in a position to succeed.”
Ask Shirshikov, however, and he’ll tell you that using a home equity loan for business may not be worth it.
“That’s because it puts your home at risk. In most cases, a small amount of capital won’t help it recover if the business isn't doing well,” he says. “If you plan to launch a business with these funds, that’s also very risky since most small businesses don’t make it.”
What interest rate can you expect to pay for a home equity loan?
The interest rate charged on a home equity loan will depend on your loan’s term. A home equity loan with a 10-year term may, for example, charge around 5.5% (on average) nowadays versus 7.25%, on average, for a 20-year term. Be aware that the lender may charge a higher interest rate if you plan to use your home equity loan funds for business purposes.
Is it better to get a home equity loan than a HELOC for your small business?
The advantage of a HELOC for a business is that you don’t begin making payments until after you begin borrowing against your line of credit. A HELOC usually has a fixed “draw period,” such as 10 years, during which you can borrow money and are only required to make minimum payments on the interest you owe. You can apply for a HELOC but never choose to use it unless necessary. In contrast, a home equity loan provides funds in full immediately upon closing, but you must start repaying the loan every month. A home equity loan typically charges a fixed interest rate, while a HELOC’s interest rate can vary. Both types of financing require using your home as collateral.
Why would a small business owner want to use a home equity loan?
A home equity loan may charge a lower interest rate than other forms of financing like a personal loan. Plus, if you own a home and have built up at least 15% to 20% equity, it can be easy to qualify for a home equity loan. Additionally, the interest charged may be tax deductible. Also, because you can use the equity in your home as collateral, it may help you qualify for a larger loan amount than you could get elsewhere.