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Data shows that cash flow issues are the reason why one in four small businesses don’t survive past the first year. It’s also the reason why half of all small businesses don’t survive beyond the fifth year.
Successfully managing working capital during the first year when you don’t have credit is a huge challenge.
Continuing to manage working capital as your business grows poses additional problems. Many small business owners seek financing specifically to provide liquidity for daily operations.
A home equity line of credit (HELOC) can be a great tool that allows homeowners to access the equity in their homes. Homeowners can use the HELOC to provide the needed liquidity into their small businesses, but there are some things to know first.
What Is a Home Equity Line of Credit?
A HELOC can give borrowers access to a maximum credit line they can use as they need. You can use the maximum amount, pay it down, and then use the credit over again. Lenders typically charge a variable interest rate and payments are based on the current outstanding balance.
A HELOC uses your home to secure the loan, so the interest rates are typically lower compared to many other financing options. Credit lines are typically open for around five years and then need to be renewed. The closing costs are much lower than mortgage closing costs, and there may be additional annual fees.
The application process for a HELOC is similar to the mortgage application process. Lenders require much of the same type of documentation that you did when you applied for a mortgage. Small business owners can have a particularly difficult time documenting their income, so be prepared to provide several years of tax returns and business financial statements.
You can learn more about the pros and cons of HELOCs here.
How Does a HELOC Compare to Other Business Loan Options?
The application process for the HELOC is less complex than the application process for a small business loan. You’ll need to provide information about your personal financial conditions and net worth in addition to your business plan and business financial statements. The amount of money you can get is highly dependent upon your personal finances and ability to repay the loan.
By contrast, most small business loans go to established businesses that have already proven their profitability. Lenders have varying requirements about the number of years you need to be in business and the minimum annual revenue of the business.
The challenges associated with traditional small business lending opened a door for online lenders who specialize in small business lines of credit. For example, Kabbage has a quick online application. Repayment terms vary from six to 12 months, and businesses can access up to $250,000 of credit at competitive interest rates.
Another online lender, Funding Circle, has opened up the door for small business owners to access credit from a global peer-to-peer lending network. Businesses fill out a brief online application and provide two years of business tax returns, personal tax returns, and business financial statements.
You’ll get a decision on your loan request within 24 hours and can have access to your credit within five days. The interest rates depend on your creditworthiness and loan request but are competitive with other financing alternatives. Borrowers can request repayment terms between six months and five years.
How To Separate Business and Personal Expenses
Separating your personal expenses and business expenses can be more complicated when you intermingle personal assets and business assets.
You’ll especially want to be careful when accounting for your HELOC expenses during tax season. Personal finance and accounting software, however, can help identify these expenses.
Risks of Using a HELOC for Business
Your home serves as the collateral for your home equity line of credit. So, the lender will foreclose on your home if you are delinquent on making HELOC payments. If you don’t have enough money to pay your HELOC, it’s probably a sign that your business is also struggling to survive.
Before you use your home equity to fund your business, you should consider if that is a risk you are willing to take.
Author: Kimberly Goodwin, PhD