Guide To Using A Home Equity Loan For Your Business

How To Use A Home Equity Loan For Your Business

Home equity is the difference between how much you owe on your home (aka your mortgage balance) and its market value. Between 2021 and 2022, accessible homeowner equity in the United States rose by 18%. Many homeowners took advantage of their increasing home values, and, in 2022, home equity loan originations in the U.S. went up by 47%, according to TransUnion. This increase represented the largest volume of home equity loans on record in over a decade. 

Homeowners can use the equity in their homes to secure affordable financing in the form of a second mortgage. Debt consolidation, home improvement projects, and big-ticket purchases are some of the most popular reasons people take out home equity loans (and home equity lines of credit, as well). Yet it’s not uncommon for entrepreneurs to sometimes take advantage of the value they have built up in their homes for business-related goals, too. 

If you want to use a home equity loan as a source of business financing you’ll need to first find a lender that allows you to use the loan proceeds for business purposes. From there, you must satisfy the lender’s qualification requirements to receive a loan. 

Qualifying For A Home Equity Loan

Every lender has different requirements that applicants must satisfy when they apply for financing. But if your goal is to take out a home equity loan for your business, here are some of the general requirements a lender may expect you to meet. 

• A credit score that satisfies its mandatory minimum cutoff point
• Proof of your ability to repay the loan 
• A satisfactory debt-to-income ratio
• A satisfactory loan-to-value ratio (LTV)

Understanding LTV

LTV is a measurement of your property’s value compared to its mortgage amount. Many home equity providers may let you borrow up to 80% of the value of your home, though exact LTV limits can vary. 

Here’s how LTV can impact your borrowing limits with a home equity loan. Imagine you owe $300,000 on a home that appraises for $400,000. In this scenario you have $100,000 worth of equity, but you wouldn’t be able to borrow that amount. If a lender limits LTV to 80%, you might qualify to borrow up to $20,000. The $300,000 you owe on your first mortgage, plus the $20,000 you want to borrow on the second mortgage ($320,000 total), would equal 80% of the current value of the home. 

Pros And Cons Of Using A Home Equity Loan For Your Business

Before you tap into your home equity as a funding source for your business, it’s important to take a close look at the benefits and drawbacks of this type of financing. 

Pros

• Easier approval criteria – Home equity loans tend to be easier to qualify for compared with traditional business loans or SBA loans. 
• Lower interest rates – Because you’re pledging your home as collateral, there’s less risk involved for the lender. This typically translates into lower interest rates for the borrower by extension. 
• Higher loan amount – Depending on how much equity you have available in your home, you might be able to qualify for a larger loan amount with a home equity loan than you could with another source of business financing. 
• Longer repayment period – Home equity loans often feature lengthier repayment periods compared with other business financing options. 

Cons

• Your house at risk – If you’re unable to make the payments on your home equity loan, the lender could foreclose on your home and resell it to recuperate its loss. And with around 65% of small businesses failing by their tenth year in business, according to the U.S. Bureau of Labor Statistics, using a home equity loan to finance your business is a big gamble to take as a small business owner. 
• Good personal credit needed – If you hope to qualify for the most attractive interest rates and borrowing terms, you’ll typically need good personal credit to receive these offers from lenders. Bad personal credit, meanwhile, could lead to a loan denial.
• No business credit building – Taking out a home equity loan won’t help you establish business credit for your company. 

Home Equity Loan Vs. HELOC

When you research home equity loans, you’re sure to come across a similar home-equity based financing product, the home equity line of credit (HELOC). HELOCs are another type of financing that is secured by the equity you have built up in your home. But HELOCs and home equity loans have a few key differences that you’ll want to understand. 

• Fixed vs. variable interest – In general, home equity loans feature fixed interest rates. This provides borrowers with a predictable, unchanging payment amount throughout the life of their loan. In contrast, HELOCs usually have variable interest rates that can go up or down with the market. 
• Lump sum loan amount vs. credit limit – When you take out a home equity loan, you receive a lump sum amount from a lender to use as you see fit (as long as you don’t violate any of the lender’s terms). A HELOC, by comparison, works more like a credit card. With a HELOC, a lender extends a line of credit that you can access up to a certain amount (aka your credit limit). As you repay the debt you owe (plus any interest and fees you owe), you can borrow against the same line of credit again up to the credit limit. 
• Collateral and risk – As a borrower, you pledge the equity in your home to secure both home equity loans and HELOCs. So, if something goes wrong and you fail to repay either type of debt, you risk losing your home to the lender.

Alternatives to Using a Home Equity Loan For Your Business

Using a home equity loan to finance your business could be an affordable way to secure the funding you need. However, it’s also a high-risk decision as a borrower. If you have any doubts about your ability to repay the full debt, it’s not a good idea to put your home on the line for your business. 
The good news is, there are many other types of business loans that could help you accomplish your goals. Even if you’re in need of a first-time business loan for your company, you have numerous options to consider. As you research loan choices, be sure to compare offers from multiple lenders to make sure you find the right fit for your business.