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Home equity loans and home equity lines of credit (HELOCs) let you turn the equity you’ve built in your home into cash. Lenders typically don’t restrict how you use the money from these loans, so using a home equity loan to start a business is something that you can do.
However, just because home equity loans are an option for funding your business doesn’t mean they’re the right choice. Home equity loans can be risky because they put your home up as collateral. There are other financing options for starting a business that might be a better choice.
On this page:
- Pros & cons of using home equity to start a business
- How you can use a home equity loan or HELOC to start a business
- Home equity loans vs. small business loans
Pros & cons of using home equity to start a business
- Easy to qualify. If you own a home, home equity loans and HELOCs are typically easier to qualify for than other loan types because of the collateral you provide.
- High loan limit. If you have a lot of equity built, you can borrow large amounts using home equity loans, typically more than you could get with other types of loans.
- Low interest rates. Home equity loans have low interest rates compared to unsecured loans like personal loans.
- Long repayment term. Home equity loans often have longer repayment terms than other types of loans, making the monthly payment smaller.
- You are putting your home at risk. If you can’t make payments on the loan, your lender could foreclose on your home, which usually isn’t a risk for unsecured loans.
- Upfront costs. Home equity loans often involve closing and other upfront costs, so you’ll need some money to cover those costs.
- Only an option for homeowners. If you don’t own your home, or don’t have much equity built, you can’t get a home equity loan.
How you can use a home equity loan or HELOC to start a business
If you’re considering leveraging your home’s value, these are the steps you should follow.
1) See if you are eligible for a home equity loan or HELOC
The first thing you need to do is make sure that you’re eligible to get a home equity loan or HELOC.
One of the main things that lenders look at for home equity loans and HELOCs, aside from your credit history, is your loan-to-value (LTV) ratio. This ratio compares the size of your mortgage to the value of your home. Most lenders limit the amount they’ll lend to you to 90% – 95% LTV.
For example, if you own a home worth $500,000 and work with a lender with a max LTV of 90%, you can’t get a loan that would push your home-related debt past $450,000 (90% of the home’s value). If your mortgage balance is $350,000, that means your maximum loan is $100,000.
You can use our home equity loan calculator to find your current LTV and how much you may be eligible to borrow.
2) Decide if using home equity to start a business is the right move
You should also take a moment to consider whether using your home equity is the best way to finance your business. Home equity loans and HELOCs use your house as collateral, putting it at risk. If you can’t pay the loan, the bank might foreclose on your home.
If you use unsecured loans, you aren’t putting your home at direct risk. You need to be confident in your business or take a significant risk of using your home equity to finance your business.
3) Decide on a home equity loan vs. a HELOC
Consider your business’s funding needs and whether a home equity loan or HELOC is a better choice.
Home equity loans give you a lump sum of money that you can use as you need. The interest rate for a home equity loan is usually fixed, which means you can predict your monthly payment over the life of the loan. They’re best for large, one-time expenses.
HELOCs turn your house into something like a credit card, giving you the option to draw from the equity in your home as often as you need to during the HELOC’s draw period. HELOC rates usually start lower than home equity loan rates, but they’re variable, so the rate could rise over time.
HELOCs are suitable for businesses that will have small, ongoing expenses that you need to cover. A company that regularly needs to buy new inventory may benefit from using a HELOC over a home equity loan.
4) Find a lender to work with
With any kind of loan, choosing the right lender is important. That is no different when you’re shopping for a home equity loan or HELOC. Taking the time to comparison shop can save you a lot of money.
One of the most important things to compare between lenders is the interest rate that each lender offers. The lower the rate, the better because lower rates reduce your monthly payments and mean you’ll pay less for the loan overall.
Another thing to compare is the closing cost of the loan. Most home equity loans and HELOCs have upfront fees. Working with a lender with lower or no fees can save you a lot of money.
Don’t forget to check with the bank that you use for your mortgage or bank accounts. Many offer loyalty bonuses that can make their offers much more competitive. Our guides to the best home equity loans and best HELOCs can help you get started searching for the right lender.
5) Use your funds and begin repayment
Once you’ve received your loan or HELOC, you’re ready to use the funds and start repaying your debt. Remember that home equity loans come in a lump sum, while HELOCs let you make multiple draws on your home’s equity whenever you need to do so.
The repayment of home equity loans and HELOCs are slightly different. With home equity loans, repayment usually begins right away. You’ll start getting monthly bills and have to send a payment each month.
With a HELOC, you only have to make payments when you use the HELOC to borrow money, much like a credit card. During the draw period, you can borrow from the HELOC, repay the balance, and borrow again as often as you need to, up to your borrowing limit.
After the draw period ends, usually about ten years, you’ll start getting a monthly bill for the HELOC balance. You’ll typically have to pay the balance down over the next ten to fifteen years.
Home equity loans vs. small business loans
If you’re not confident that using your home equity is the best way to fund your business, you should take time to consider other options. Many lenders offer specifically designed small business loans to help people get new businesses off the ground.
|Home equity loans||Business loans|
|Rates||Low, fixed or variable||Medium, fixed or variable|
|Loan Amounts||Based on home value and LTV||Varies by lender|
|Repayment Terms||Can be up to 30 years||Can be up to 10 years|
|Fees||Closing costs and origination fees||Origination fees, sometimes annual fees|
|Minimum credit score||Typically around 620||Varies by lender, usually higher than home equity loans|
Here is a direct comparison of four home equity and small business lenders:
Author: TJ Porter