How To Use Your Home Equity To Build A Business

For many aspiring entrepreneurs, building a new business is part of their American dream. But raising startup capital can often be easier said than done. Owning a home unlocks a unique funding opportunity for entrepreneurs. They can tap into the equity in their homes to raise the capital they need to fund a new or growing business.

Tapping into the equity in a home to fund a business endeavor may be convenient, but it’s a potentially risky strategy. While a home equity loan can help you grow a business, it’s critical to understand how to use it to maximize the benefits and minimize the risks.

What Is A Home Equity Loan?

A home equity loan, also known as a second mortgage, lets you access your home equity as a lump-sum loan. Your home is the collateral that secures the loan.

Home equity represents the difference between your mortgage balance and the current market value of your home. If your home is worth $250,000 and you owe $100,000 on your mortgage, you have $150,000 in home equity. Each mortgage payment you make grows your home equity (the portion of the home you own outright).

Can You Use A Home Equity Loan To Start A Business?

Homeowners who need business financing can access their home equity to acquire funds. If you have enough equity in your home, you can secure a home equity loan and use that much-needed injection of capital to start or grow your business.

How Does Using A Home Equity Loan For Business Work?

Here are the general steps to secure a home equity loan for business:

Calculate Your Home Equity

A good place to start before using a home equity loan to launch a business is to determine how much equity you have in your home. You can calculate home equity by subtracting your mortgage balance from your home’s market value.

Most lenders allow homeowners to borrow up to 85% of their home equity. For example, with $100,000 in equity, most lenders will cap the amount you can borrow at around $85,000.

Check Your Credit Score

Next, take a look at your credit score. Borrowers with higher credit scores generally secure lower interest rates, potentially saving them thousands of dollars. If your credit score is less-than-ideal, consider holding off on the home equity loan until you can improve your score.

Remember, a home equity loan is a second mortgage, and missed payments can hurt your score. Take a realistic look at your budget to ensure you can cover the loan payment and keep your credit score in good standing.

Apply For A Home Equity Loan

After carefully reviewing your finances, it’s time to shop around for a lender. While comparison shopping, check out the annual percentage rates (APR) and fees lenders are charging. The goal is to find the most affordable loan option for you.

Applying for a home equity loan is similar to applying for a mortgage. The lender will require extensive documentation of your financial situation. They may ask for W-2s, 1099s, recent pay stubs, bank statements and mortgage documents.

Use The Funds To Grow Your Business

You’ll receive a lump-sum payment after approval. While you can use money from a home equity loan for various purposes, in this scenario, you’ll dedicate the funds to launch or expand your business. You can use the funds for everything from buying specialized equipment or spending on marketing to roll out your brand.

Repay The Funds

You’ll agree to repay the loan with fixed monthly payments over a specified loan term. Because a home equity loan uses your house as collateral, on-time payments are crucial to keep building equity and avoid the risk of losing your home.

Pros And Cons Of Using A Home Equity Loan For Business

Every financial decision has pros and cons to consider. Let’s explore the advantages and disadvantages of using a second mortgage to fund a business.

Advantages

Let’s start with the advantages of using a home equity loan for business, including:

• Access to funding: A home equity loan can be a convenient option to get the money you need to build or grow your business.
• Competitive interest rates: Home equity loans usually have lower interest rates than other financing options, such as credit cards or personal loans. The rates are typically lower because the home secures the loan.
• Potentially large loan amounts: Depending on the amount of equity in your home, you may be able to access a significant amount of money.
• Fixed monthly payments: When you close on a home equity loan, you commit to a fixed monthly payment. Adding the payments to your household budget is typically easier because they’re predictable.
• Flexibility: You can use the funds however you like. You won’t need to justify spending the money to build a business empire.

Disadvantages

Using a home equity loan for business has downsides, including:

• Home used as collateral: You may lose your home if you can’t keep up with your loan payments.
• Personally responsible for repayment: Whether your business idea flies, falters or fails, you’re ultimately responsible for repaying the home equity loan.
• Funding limits: Most lenders won’t allow a homeowner to borrow more than 85% of the equity in their home. Depending on how much equity you have in your home, you may not be able to secure a loan large enough to fund your business venture entirely.
• Income verification: Most lenders require proof of income before finalizing a home equity loan. If your income isn’t stable, it may make loan approval challenging.
• No business credit: Since a home equity loan is linked to your personal credit history, on-time payments won’t help you build business credit.

Alternative Ways To Fund Your Business Needs

A home equity loan for small business funding is a possible solution – but it’s not the only one. Explore some alternatives to getting your hands on the cash you need.

Home Equity Line Of Credit

A home equity line of credit (HELOC) is another funding solution that uses your home as collateral. If you have significant equity, you can use a HELOC to jump-start or scale your business.

A HELOC has two distinct phases. During the draw period, it works like a credit card, allowing a borrower to withdraw funds from a line of credit as needed, up to its predetermined credit limit. You can use the funds to cover business expenses. And you’ll only need to make minimum monthly payments.

Once the draw period ends, you’ll start the repayment period. During this phase, you can no longer borrow funds and must make regularly scheduled payments over a set term. Because most HELOCs have variable rates, your interest rate will fluctuate with the market, and your monthly payments can increase.

A HELOC provides the flexibility to withdraw funds as needed, ensuring you won’t borrow more than you need to get your business off the ground. Like a home equity loan, you risk losing your home if you can’t keep up with the payments.

Personal loan

If you don’t have enough home equity or don’t want to use your house as collateral to finance your business, consider an unsecured personal loan.

With a personal loan, a borrower receives an upfront lump sum they repay in installments over a specified term. Because they’re unsecured, personal loans typically have higher interest rates than secured loans. However, if you fall behind on your monthly payments, the lender can’t seize your home or any other personal asset.

Small Business Loan

Small business loans cater to business owners who need funding. With a small business loan, you receive funds upfront and repay them in fixed monthly installments.

Unlike a home equity loan, a small business loan doesn’t use your home as collateral. While a lender can’t seize your home or any other asset if you miss payments, missed payments can hurt your credit score and damage your credit history.

Small Business Credit Card

With a small business credit card, you can make purchases to operate your business. The card typically requires at least a minimum payment based on your spending.

While credit cards have relatively high interest rates, you won’t have to worry about losing your home due to missed payments.

The Bottom Line

Homeowners with sufficient equity and steady finances may consider using their home equity to finance their business ventures. If you’re considering using the equity in your home to fund your entrepreneurial dreams, you can start the home equity loan application process today.