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Home Equity Business Loan: Risks and Benefits

Are you both a homeowner and a small business owner? You might find money you need to grow your business in the value of your home. A home equity loan (HEL) can unlock additional funding that your small business needs. However, home equity loans for business aren’t risk-free. We’ll cover some pros and cons so you can make an informed decision about using a HEL to fund your business growth.

What Is a Home Equity Loan?

A home equity loan (HEL) is a form of mortgage, also sometimes called a “second mortgage,” although that term isn’t often used these days. HELs are secured by your home’s value or equity. A limited number of programs enable you to borrow up to 100% of the equity (value) you’ve built up, but it’s more common to find “loan to value” — or LTV — limits of 85–90% LTV on the amount of HEL you can get.

How do you calculate how much equity is available in your home? Let’s say you own a home that’s worth $350,000, and you owe $200,000 on your mortgage. The difference of $150,000 is the approximate equity in your home. Home equity loans usually max out between 85% and 90% LTV. At 85% LTV, you could get a home equity loan of $127,500 in this scenario.

Using Your Home Equity Loan For Business

Getting a home equity loan (HEL) isn’t quite the same as using your home as collateral for a business loan. It’s also not the same financial model as a home equity line of credit (HELOC). A HELOC is a line of credit you can use as needed and can repay flexibly, like a credit card. You’ll get the funds up front with a HEL, and repay the loan on a schedule set by the lender. HEL interest rates are usually lower than small business or personal loans.

Benefits of Using Your Home Equity For Business Loan

Home equity loans can help your business access capital that’s locked up in the value of your home. Home equity loans can be approved within 2 weeks, but most take longer. Like other mortgages, most HELs rely on appraisals and mortgage underwriting processes, which lead to a 4-week or longer time frame for HEL funding approval.

Lower Interest Rates on Home Equity Loans

Because they’re tied to real estate, home equity loans offer less risk to lenders. As a result, their interest rates are always less than a business credit card or personal loan interest. Since 2008, HEL interest rates have also been lower than SBA loan interest rates.

A home equity loan is secured by the value of your home, so you could qualify for a loan with less-than-ideal credit.

Lower Monthly Payments and Total Cost Than Credit Cards

How much difference could a lower interest rate make? If you have a $15,000 credit card debt at 18.5% interest, and plan to pay it off in 4 years, you’ll make 48 monthly payments of $444.55. By the end of the 4 years, you will have paid $21,338.40 in total, including $6,338.40 in interest.

With a 4-year home equity loan for $15,000 at 6% interest, you’ll make 48 monthly payments of $352.28 for a total of $16,909.44. In this scenario, you’ll pay 68% less in interest over the same time period.

Low Credit Scores Aren’t Disqualifying

Because a home equity loan is secured by the value of your home, you could qualify for this loan with less-than-ideal credit. You might find home equity loans available for credit scores below 600. Most home equity loans are available for scores of 620 and above, with the best interest rates reserved for the most creditworthy borrowers. With lower credit scores, the interest rate advantage for HELs over other financing alternatives might not be available.

Access to Larger Amounts of Funding

If you have a lot of equity in your home, you could access $100,000 to $500,000 for your business growth. Chances are, if you have this amount of equity, you also have other assets that you can use for your business financing. Some people have used home equity loans to finance business growth during the first few months of business operations. If your debt-to-income ratio is low, a home equity loan could be an attractive choice to access larger levels of business funding.

Disadvantages of Using Your Home Equity For a Business Loan

As you research this source of funding, it’s important to understand the terms and potential risks of using home equity to finance your business. These loans use your home as collateral, and if you can’t repay the HEL, you risk losing your home to foreclosure.

Understanding the Foreclosure Risk

Lenders offer lower interest rates on mortgage loans because there’s less of a risk for this financing. If you can’t pay back the loan, your property can be sold to recover the money. If you have a first mortgage on your home and take out an additional home equity loan, the original mortgage lender has the first right to money from a foreclosure sale. The first mortgage lender must also notify your home equity lender of the foreclosure. They will get any funds remaining after the initial lender completes a foreclosure sale.

Closing Costs, Appraisals, and Processing Fees

Home equity loans have lower interest rates than unsecured loans or credit cards, but they also come with additional costs that you should consider. As a real estate-secured product, the HEL will have title, appraisal — and often — loan origination and processing fees. While you might be able to find lenders who are willing to waive some fees, a home equity loan will cost an estimated 2% and 5% of the total loan at closing.

You need to have built equity or value in your home to get a home equity loan.

You Need Equity to Get The Loan

You need to have built equity or value in your home to get a home equity loan. If you’re just starting out in your business career and home ownership, you may not have built enough equity in your home mortgage to qualify for a HEL. Although it’s possible to get a loan with as little as 15% equity, it’s not common. Count on needing at least 20% equity to qualify for an HEL.

Extensive Documentation Required

Lenders underwrite HELs using mortgage standards. Although lenders differ in the amount and type of documentation they require to offer a real estate-backed loan, you will likely need to document your income for up to the past 2 years.

Tax Impacts of a Home Equity Loan

To get a tax deduction for your home equity loan interest, the money needs to be used for qualified expenses, including home improvements or room additions. However, if you use the loan for your business and not your home, you can’t deduct the interest on your personal income tax. If you’re incorporated, getting a home equity loan will link your personal residence to your corporation.

Alternative Business Funding Options

Depending on your needs, you have several alternatives to a home equity loan to fund your business.

Equipment Financing: Get a loan to pay for new equipment secured by the equipment itself, not the equity in your home. Interest rates can start at 8% and can fund in as little as two days.

Accounts Receivable Financing: Get funds you need for your business now based on your receivables billing. Get the benefit of work you’ve already completed. You can get funding in as little as 24 hours.

Small Business Line of Credit: Offers you a flexible, revolving line of credit that replenishes as you make payments.

Commercial Business Loan: You’ll find more commercial business loan alternatives now than ever before. Commercial loans offer varying terms and repayment structures.

SBA Loans: With interest rates starting at 7.25%, established businesses can get SBA loans up to $5 million.

A home equity loan offers money to fund your small business, but you also have many alternatives. Fast Capital 360 can help you to get the money you need to achieve business goals. You can apply for business lines of credit, commercial business loans, or financing for equipment. You can also strengthen your cash flow through accounts receivable financing.

Amy Casil is a Southern California-based business planner and writer, as well as a former nonprofit housing and economic development executive. She is passionate about small business and has helped over 190 businesses to get funding to start up or expand.
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