Funding Your Business With A Home Equity Loan

Should you obtain a home equity loan or home equity line of credit to fund your small business?

Starting a business requires money, typically more than most people have been able to save or can easily borrow from friends and family. So, lacking ready cash, they often turn to their biggest assets, the equity in their homes. However, there is much to consider before tapping into your home equity.

Borrowing off equity in your home is considered a second mortgage; however, there are two different methods by which you can obtain cash from your home, and as we will see, each has its advantages and disadvantages.

The Home Equity Loan

A home equity loan behaves in the same manner as most mortgages do. Home equity loans are usually obtained at a fixed rate, and for a specific period of time. The interest rates on these types of loans are competitive; however, interest will be somewhat higher than on a first mortgage.

Home equity loans follow the same closing procedures as do first mortgages, but they do not take nearly as much time to close. These loans are paid back on a monthly basis, similar to a first mortgage. Since a home equity loan has a fixed interest rate and a uniform monthly payment, the borrower knows exactly what needs to be paid each month. The borrower is also aware that the interest rate will not rise during the course of repayment.

The Line of Credit

A home equity line of credit is different in that the borrower takes cash from it as needed. The time in which one is able to withdraw money (also called a draw period) usually lasts 10 years. The borrower does not need to pay anything back on a home equity line of credit unless he or she takes money from it. Any money taken from the line of credit must be repaid in its entirety, along with any interest, by the end of the draw period. Interest on this type of loan is variable.

If you overestimate the profits of your new business — and many, if not most, new small business operators do, you will need to dip further into your credit line. You do not want to put your home at risk in order to make a living.

If your home equity line of credit carries an adjustable interest rate, your rate may increase considerably . Consider that the money you borrowed would cost much more, thus cutting into any gains you would have made. Interest rates are at an all-time low; however, it is best to be cautious.

Funding a small business using a home equity loan is inherently risky. Since you are using your loan or line of credit to fund a business … you might not be able to deduct the interest on your tax return; therefore, you may be stuck paying tax on capital gains

What do you need to know?

Funding a small business using a home equity loan is inherently risky. Since you are using your loan or line of credit to fund a business as opposed to renovating a property, you might not be able to deduct the interest on your tax return; therefore, you may be stuck paying tax on capital gains. Also, if you have a financial or medical emergency, and the equity in your house is tied up in your business, you will end up in trouble if you have no other liquid asset to draw upon.

However, once you have carefully considered both the risks and the opportunities, and have decided to move ahead, there are things that you can do to lower your exposure.

How to Lower Your Interest Rate

First, make sure that all your other debts are paid before applying for a home equity loan or line of credit. This includes credit card debt, student loans, and any other outstanding loans. Paying off all outstanding loans will raise your credit score and increase your chances of getting a lower interest rate.

Consider staying at your day job until you get your loan. A guaranteed paycheck increases your chance of getting your loan.

Borrow Less to Keep Interest Payments Down

Second, borrow only what you need, even though lenders will allow you to borrow up to 80% of the current worth of your home. You may be tempted to ask for more, but you do not want to be paying interest on a larger amount on a home equity loan; likewise, you do not want to be tempted to dip into a bigger till with a line of credit.

Shop Around for Best Rates

Next, shop around. There are several home equity loans and lines of credit available today. Since you are making a long-term decision that carries some risk, you really want to be sure you are making the correct choice.

Common Sense Advice

Consider staying at your day job until you get your loan. A guaranteed paycheck increases your chance of getting your loan. Finally, remember that borrowing from the equity in your home entails risks, so be sure you perform your due diligence in order to make the correct decision for you and your family.