Typically, home equity loans are used for home repairs or remodeling projects. However, the funds provided by home equity loans can be used for any purpose. Learn the pros and cons of using a home equity loan to start a business, as well as alternative options for funding your startup.
Can You Use a Home Equity Loan To Start a Business?
The lump sum of funds provided by a home equity loan can be used for any purpose, including expenses to start a business. Borrowers should, however, consider the consequences of using their home as collateral for this purpose, because starting a business often can be risky. Most new businesses aren’t able to succeed and generate a profit or positive returns to investors, although the failure rate flattens out after about five years in most industries. The ability to pay back this type of loan used to back a new business depends on the success of the business, which may be up in the air. With this level of uncertainty, it’s important to weigh the pros and cons of pursuing a home equity loan for this use.
Pros and Cons of Using Home Equity To Fund a Business
Pros Explained
Can be used for any purpose: Home equity loans are beneficial for business founders because the funds can be used in any way, including to cover expenses incurred in starting an operation. Qualifying may be easier with collateral: Because it’s a secured loan—guaranteed with your home’s equity—qualifying is typically easier. Retain full ownership of your business: Another advantage of using this loan type to fund a startup is the ability to keep full ownership of your firm. By financing the expenses on your own, you won’t need investors, who usually would seek some form of ownership in the company. Lower interest rates and other favorable terms: Secured loans such as a home equity loan may have more beneficial terms, including better interest rates and more flexibility, such as differing term lengths.
Cons Explained
House at risk of foreclosure if loan is unpaid: The main risk of this loan is the possibility of foreclosure on the home if the borrower fails to make payments. Using a home as collateral gives the lender rights to the property if the borrower doesn’t make payments. Added debt in the form of interest and other fees: Obtaining a home equity loan adds to your existing debt load in the form of interest and other fees, in addition to creating another payment you’re liable for. Impact on personal credit score: The home equity loan can affect personal finances, including your credit score. As a business owner, this should be considered because your credit score is often referenced by lenders, as is your debt-to-income (DTI) ratio. Interest is not tax-deductible: Another potential drawback is that interest incurred from a home equity loan isn’t tax-deductible when used to start a business. While the IRS allows deductions for interest on home equity loans, these are specifically for funds spent on renovating or improving the house in some way. Value of loan is lower than home’s value: The amount of proceeds offered by the lender in this format customarily is much lower than the actual value of the home.
Keep in mind that taking out a home equity loan isn’t the only way to retain ownership as you get your business started; there are other options available.
Other Ways To Fund Your Business
There are many other ways to fund a business that won’t require your home to be used as collateral. Each of these types of loans may have different requirements; some lenders will be more lenient than others.
SBA Loans
A loan guaranteed by the U.S. Small Business Administration (SBA) is a good alternative for those who qualify. These loans offer a low interest rate, and some SBA loans may not even require collateral.
Conventional Business Loans
A conventional business loan is the traditional type of loan, paid off in installments, that’s offered for this purpose by banks or credit unions. Lenders aren’t provided a guarantee as with SBA loans, so they typically have stricter requirements for approval.
Business Line of Credit
A business line of credit or a credit card can provide continuous funds, as long as the balance is paid off at the end of each billing cycle. This option doesn’t provide a lump sum, but it can help businesses cover expenses as they grow.
Loans From Alternative Lenders
Alternative lenders, or online lenders, often are more lenient than banks. Entrepreneurs who don’t qualify for other business loans may qualify with alternative lenders. These lenders offer higher interest rates, but the application process is faster and simplified.
Is Using Home Equity for Your Business a Good Idea?
While each business is different, it is typically not advised to use a home equity loan for business expenses unless you’re confident you can pay it back. To ensure you’ll be able to retain the rights to your home, analyze solid data that shows that the business can bring in sufficient revenue, such as customer orders or other forms of expected income. Before you apply, consider all your options for funding. Using a house as equity to start a business has its risks, whereas other business funding options may not require collateral. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
