Using a Home Equity Loan to Finance Your Business

Taking out a home equity loan (HEL) to finance your business is easier than getting traditional startup business loans. Individuals with equity in their home and strong personal credit can use a home equity loan for large one-time expenditures or other capital influx needs in the business.

If you are considering using a home equity loan to finance your business, you may want to consider LendingTree. With its online marketplace, LendingTree allows you to compare rates and offers from various lenders to find the financing option that is right for you.

Visit LendingTree

How Using a Home Equity Loan to Finance Your Business Works

Using your home as collateral, you can get a home equity loan to finance your business. You’ll typically need to have a strong personal credit score of 660 or more, at least 10% to 20% equity in your home, and a debt-to-income (DTI) ratio lower than 50% to qualify.

A home equity loan works similarly to most other term loans. It is secured by your home, where a lump sum of capital is repaid over the course of up to 30 years. Typically, your interest rate is fixed throughout repayments. This is unlike a home equity line of credit (HELOC), which usually has a variable rate and can be drawn on with a revolving line of credit.

Home Equity Loan for Business Purposes at a Glance

*Note: Based on combined loan-to-value ratio (CLTV), which is the total of the existing first mortgage on your home and the new equity loan amounts combined and compared to the home value.

When to Use a Home Equity Loan to Finance Your Business

Because the home equity loan is a one-time funding option that pays a lump sum amount, you’ll want to have clearly defined goals for using it. Larger equity amounts often are used for major, one-time expenses. However, you could use the lump sum as working capital to cover financing needed for operating expenses.

Some good opportunities to use a home equity loan to finance your business include:

• Equipment purchases: Buying equipment that is critical to your business can be expensive, especially with equipment financing. A home equity loan can help you afford the equipment you need at a relatively low cost.
• Major remodeling: If your storefront or office space is in need of a major upgrade, a home equity loan can provide the funding needed to get the project done quickly and all at once.
• Business acquisition: Buying a business typically requires a large amount of capital, which is why a home equity loan is often used as a down payment on a Small Business Administration (SBA) loan to acquire a business.
• Opening a new location: If your business is growing and you need to expand and open a new location, upfront costs can be high. Although a commercial real estate loan is recommended for the location, other expenses like furnishings, inventory, and equipment can be paid for with a home equity loan.
• Large upfront startup costs: If you are starting a business, you can use a home equity loan for startup funding. Many startups can get away with office space and a few computers. However, if you need a location, equipment, signs, and initial inventory at the same time, a home equity loan is the best option.

Home Equity Loan: APR

HELs are an inexpensive way to finance your business compared to some alternatives like online business loans, which have APRs of 30% to 50%. Typically, the APR for a home equity loan ranges from 4% to 8%.

A home equity loan typically has a fixed rate throughout the life of the loan. This rate will largely depend on your repayment ability and your personal credit score. This typically means that if you have a higher credit score and lower DTI ratio, you can receive a lower APR on the loan.

Home Equity Loan: Fees

Some fees you will encounter when getting a home equity loan to finance your business include:

• Origination fees: Up to 1% of the loan amount
• Third-party closing costs: 2% to 5% of the loan amount, which covers application processing, appraisal of home value, and so on
• Prepayment penalty: Up to 3% of the loan amount

Paying back debt early should be a good thing. Unfortunately, however, you can get hit with prepayment penalties or early closure fees. Remember, HELs are tied to homeownership, so if you sell your home, you must pay off the loan or line of credit. If you’re not planning to keep your home for at least another three years, now may not be the best time to get a HEL.

Home Equity Loan: Repayment Terms

Like other term loans, a HEL is amortized over several years. This means that you pay back interest and principal every month during the term of the loan, which generally ranges from 10 to 30 years. Your monthly payments will depend on the size of the loan.

Home Equity Loan: Qualifications

The typical qualifications you will need to meet to get a home equity loan to finance your business are:

• Credit score: 660 or greater
• Home equity: At least 10% to 20%
• Debt-to-income ratio: Up to 50%, with most traditional lenders allowing up to 43%

Home Equity Loan to Finance Your Business: Loan Amount

For most home equity loans, you can borrow up to 80% to 90% of your combined loan-to-value ratio. Although this is the maximum, it doesn’t mean that you should borrow this much. Simply because you can qualify for a large loan doesn’t mean you should take it. The total cost of a HEL depends in part on the size of the loan that you take, so you should calculate how much you need to borrow and only borrow that much. However, most banks have size minimums for HELs and won’t grant a HEL below $10,000.

The following is an example of how the numbers work out when borrowing from home equity to start a business.

Maria and Matt own a home that’s valued at $500,000, and they’ve paid off half of it, including their down payment. They want to use a home equity loan to start a new business:

When your lender considers how much to lend, it will look at your ability to repay the loan with your current income. Thus, having higher monthly payments with a HEL can reduce the amount that you can qualify for.

How to Get a Home Equity Loan to Finance Your Business

You can get a home equity loan for business financing from most traditional lenders that offer a mortgage. You don’t have to go to the same bank that issued your first mortgage if you have one. However, using the same lender can sometimes result in better overall rates.

To apply for a home equity loan, you will need to provide your personal tax returns and financial statements. Your lender will also require that a property evaluation is done to determine its value, which will play a large role in how much you can borrow. From there, your loan will go through underwriting, with the entire process from application to funding typically taking 30 to 45 days.

Using a traditional lender, especially a bank that you already have an established relationship with, is always a good idea. However, comparing rates from several banks can take a long time. Instead, you can use an online marketplace, like LendingTree, to compare offers from multiple lenders after completing a short online application.

Home Equity Loan Pros & Cons

If you don’t want to risk your home, small business credit cards can be easy to qualify for and a cost-effective way of financing your startup. Many come with 0% APR introductory periods and valuable cash back or rewards programs. Check out our review of the best small business credit cards.

Bottom Line

Home equity loans are an inexpensive way to finance your business. A HEL is best for predictable and one-time costs. If you have at least 10 to 20% equity in your home and a 660 or greater personal credit score, you should be able to qualify.