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A home equity line of credit (HELOC) allows you to borrow money as you need it, tapping your home’s equity at a relatively lower rate and using the funds for virtually any reason. Using a HELOC for business purposes, however, can come with risks, such as losses due to an uncertain business climate and the ramifications of putting your home’s equity on the line.
- Just 10 percent of small business owners rely on home equity for start-up financing, according to the Federal Reserve. Other sources include savings, bank business loans and credit cards.
- Small business owners who applied for a HELOC were approved 70 percent of the time, compared to a 57 percent approval rate for a bank business loan and a 43 percent approval rate for a personal loan, according to the Federal Reserve.
- The average borrower had $207,000 in available home equity as of April 2022, according to Black Knight.
- The average cost of starting a small business ranges in the thousands to hundreds of thousands depending on industry (for example, a restaurant). This covers the operational space (office or otherwise) and costs pertaining to hiring, insurance, licensing, marketing and other expenses.
- There are 32.5 million small businesses in the U.S., according to the U.S. Small Business Administration, and approximately 11 percent of U.S. workers are self-employed, according to Census estimates.
Is it a good idea to use a HELOC for my business?
If you can afford to repay it, using a HELOC for your business could be a good idea. You might get lower interest rates than you would otherwise, and the rotating credit means you only need to borrow what is necessary.
Pros of using a HELOC for business
- Easier to qualify for: Since a HELOC is a secured loan — using your home as collateral — the lender considers the loan less of a risk. Because of this, a HELOC is usually easier to qualify for than an unsecured personal loan, which doesn’t have an asset attached to it.
- More flexible repayment periods: HELOCs come with draw periods that usually last 10 years. During this period, you can withdraw funds and only need to repay interest on the amount you borrow. Once the draw period ends, you’ll typically have 15 years to 20 years to repay the principal and interest. (Keep in mind that fluctuating monthly payments can hurt your credit if you find you’re unable to afford them.)
- Large amounts might be available: If you have a large amount of equity in your home, you might be able to borrow a large amount of money with a HELOC. Some lenders allow you to borrow up to 85 percent of your home’s combined loan-to-value (LTV) ratio.
Cons of using a HELOC for business
- Variable interest rates: Although you might secure a low rate initially because the interest rate is variable, it could rise in the future. This would cause your borrowing cost to increase. The unpredictable nature of the interest rate can make it more difficult for you to create a repayment plan. Use a HELOC calculator to estimate how much your monthly loan payments might change if the rate goes up or down.
- Risk of defaulting: If your business fails or you experience financial hardship and find yourself unable to repay the loan, the lender can foreclose on your home. This will also cause your credit score to suffer a major blow, making it harder for you to qualify for future loans.
Alternatives to using a HELOC for your small business
Home equity loan
A home equity loan is similar to a HELOC in that it is a loan secured by your home. Unlike a HELOC, however, it usually has a fixed interest rate and the funds are issued as a lump sum. If you choose this option, the fixed monthly payments might be better for your budget. Also, it has lower average interest rates than personal loans and credit cards.
Unlike home equity loans, personal loans are usually unsecured — the lender can’t seize your assets without a court’s permission. When a lender reviews your application, approval depends heavily on factors such as your income, debt-to-income (DTI) ratio and income. Although the length of loan terms varies based on the lender, the range is usually from one year to five years.
Small business line of credit
A business line of credit is a loan that works similarly to a credit card and HELOC in that you borrow money on an as-needed basis. Business lines of credit can be secured or unsecured, and interest rates vary between the two options.
A business line of credit might meet your needs if you’re looking for extra cash flow, such as during seasonal fluctuations, for an increased short-term expense or to cover customers who take longer than 30 days to pay.
Small business credit card
A small business credit card works like a regular credit card, but you use it for business expenses. If you pay off the card’s balance on or before the due date, you can avoid paying interest altogether. In addition, some small business cards come with interest-free periods that last up to 12 months. As long as you pay the balance off before the promotional period expires, you can avoid interest payments.
Secured or unsecured business loan
Another option you have to fund your business expenses is taking out a secured or unsecured business loan. When you take out a secured business loan, the lender will require you to secure the loan with an asset. Although you can use a business asset — land, equipment or a building — lenders will let you choose what type of collateral to pledge. An unsecured business loan doesn’t require collateral.
To qualify for a small business loan, your business will have to meet the lender’s minimum requirements. For example, some lenders require that your business has existed for a certain number of years or generate a minimum amount of annual revenue.
When choosing between using a HELOC for business and other funding options, compare the interest rate and terms of each option, the loan amount and the consequences for defaulting on the loan.
If you use a HELOC for business, you might be able to secure a lower rate and a larger loan amount than with other types of loans. However, you have to decide if the risk of potentially losing your home is worth it.
Business and home equity FAQ
Between comparing HELOC lenders and offers, putting together your application and then waiting out the underwriting period, it can take a few weeks to obtain a HELOC. Some online lenders offer much faster turnaround times, however. Depending on the lender, you might be able to access the funds as little as three business days after closing. Some lenders take five days or longer.
If you have a variable-rate HELOC (and most borrowers do), your rate will change based on changes to the prime rate, which is directly influenced by what’s happening in the economy and the Federal Reserve’s actions. The frequency depends on your specific line of credit; some HELOCs adjust once a month.
The draw period on a HELOC is the time frame when you can access funds and are only required to make interest payments. The standard draw period on a HELOC is 10 years.
Your credit score might take a small hit when you apply for a HELOC because you’re opening a new line of credit. As with any debt repayment, timely payments on your HELOC can help your credit score; missed payments will lower your score.
To pay off your HELOC faster, you can make principal payments during the draw period in addition to the interest you’re required to pay.