Pros and Cons of Using Home Equity to Fund Your Business
When you’re starting or growing your business, there’s a lot of costs to consider, from leasing property and purchasing equipment to hiring and training staff. If you’re a homeowner, you may not have considered using your home equity for business funding, but it can be a viable alternative to a conventional small business loan. Take a look at the pros and cons of each of your options below.
SBA (Small Business Administration) Loan
Maximum funding: $5,000,000
A conventional small business loan, or SBA loan, is often the first avenue for many business owners seeking funding. Backed by the Small Business Administration, these loans are provided by banks, microlenders, and commercial lenders and often feature lower interest rates and more flexibility than traditional bank loans.
However, one major challenge of traditional small business loans is the red tape and paperwork they require; many ask for a personal asset guarantee to secure the loan. It’s also important to note that if your business is especially small — say, if you’re the sole proprietor or only one of two or three employees — it might be especially difficult to secure a loan. It’s estimated that only about 15% of sole proprietorships have business loans.
Did your SBA loan application get rejected? Learn why and the next steps you can take >>
Home Equity Loan for Business
Maximum funding: Typically up to 80-85% of your home’s value
A home equity loan lets you borrow against the equity you’ve built in your home, using the home to guarantee the loan. On the plus side, these loans offer predictable interest rates, so your monthly payment remains the same every month, which can be especially appealing if you’re looking to use a home equity loan for business purposes.
And unlike most business lines of credit, you aren’t required to pay the balance down to zero each year. In fact, a home equity loan can be appealing for its generally flexible repayment periods, which typically range from 5 to 15 years. In addition, it’s possible that the interest on your home equity loan will be tax deductible.
However, a home equity loan is a second mortgage on your home, so you’ll need to be prepared to make an additional payment on top of your existing mortgage. The application and approval process can also be a bit challenging due to lenders’ specific requirements.
Home Equity Line of Credit (HELOC) for Business
Maximum funding: Typically up to 80-90% of your home’s value
If you’re looking for flexibility, a HELOC for your small business can be a good option, as it gives you the opportunity to access funds any time and you can take out more as needed without any penalties. The application and approval process also tends to be easier than other options. As with a home equity loan, there’s the possibility that the interest will be tax deductible, and the repayment period typically spans from 15 to 20 years.
Yet unlike a home equity loan which usually has a fixed rate, the variable interest rate of a HELOC means that payments will be unpredictable every month. In addition, if your credit score or home value decreases, the lender can freeze your HELOC at any time.
Home Equity Investment
Maximum funding: Up to $400,000 (or 30% of your home’s value)
A home equity investment gives you cash in exchange for a share in the future value of your home, but unlike a loan or HELOC, you don’t have the hassle of monthly payments or interest. You can use the cash for anything you’d like, whether it’s purchasing equipment, making office renovations, or expanding operations. The timeline is also relatively quick, and once you’re approved, you can receive funds in as little as three weeks. At or before the end of the 10-year effective period, you’ll need to settle the investment — through a refinance, buyout with savings, or sale of your home.
With all home equity products, a homeowner is putting their home on the line in hopes of fostering their business’ success. But what makes a home equity investment a bit different from the other options is the downside protection it offers. If the home value depreciates over time, the amount that’s owed to home equity investment providers like Hometap also goes down, and there’s no guaranteed return on its investment. And conversely, if a home sees rapid appreciation, Hometap’s upside is capped at 20 percent of the Investment per year.
Take our five-minute quiz to see if a home equity investment might be a good option for funding your small business.
YOU SHOULD KNOW…
We do our best to make sure that the information in this post is as accurate as possible as of the date it is published, but things change quickly sometimes. Hometap does not endorse or monitor any linked websites. Individual situations differ, so consult your own finance, tax or legal professional to determine what makes sense for you.
Hometap is made up of a collaborative team of underwriters, investment managers, financial analysts, and—most importantly—homeowners—in the home financing field that understand the challenges that come with owning a home.