Using a HELOC or Home Equity Loan to Finance Your Business

Taking out a home equity line of credit (HELOC) or home equity loan to finance your business is easier than getting traditional startup business loans. Individuals with equity in their home and strong personal credit can use HELOCs for ongoing expenses, whereas home equity loans are best for large one-time expenditures.

If you’re shopping for a home equity line of credit, you can reach out to one lender at a time hoping you find a good deal. Or, you can visit an online marketplace, like LendingTree, and review offers from multiple lenders at once. Save time, shop smart, and find a HELOC that fits.

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How Using a HELOC or Home Equity Loan to Finance Your Business Works

Using your home as collateral, you can get a home equity line of credit or 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 ratio lower than 50% to qualify.

A home equity line of credit has a variable rate and is revolving, allowing you to borrow funds again once the initial borrowed amount is repaid. Repayment typically happens in two stages. In the first stage (lasting up to 10 years), you can draw on your line of credit while making interest payments. In the second stage, your line of credit will convert into a term loan with amortized repayment up to 20 years, and you will no longer be able to draw additional funds.

On the other hand, a home equity loan (HEL) works similar to most other term loans. It’s also secured by your home, except rather than drawing on the amount you receive, a lump sum of capital is repaid over the course of up to 30 years. Typically, your interest rate is fixed throughout repayments, unlike a HELOC, which usually has a variable rate.

Home Equity Loan vs Home Equity Line of Credit for Business Purposes at a Glance

* Note: Based on combined loan-to-value ratio (CLTV)

Whether you want to check if you qualify, or if you wish to see what rates different lenders are willing to offer, you can use LendingTree. LendingTree allows you to apply for a home equity loan or line of credit and compare rates and offers from different lenders in a few minutes.

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When to Use a Home Equity Loan to Finance Your Business

Using a home equity loan to finance your business purchases is best done when you have a large one-time expense, since the loan is not revolving. This includes equipment purchases, major remodeling, business acquisitions, and opening new locations. Additionally, you could use a home equity loan as a down payment on other financing, like an SBA loan.

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 get you the funds you need 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 an 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 should use a home equity loan if you need startup funding. Many startups can get away with office space and a few computers, but if you need a location, equipment, signs, and initial inventory at the same time, a home equity loan is the best option.

It’s best to use a HEL for the purchase of business assets (e.g., equipment) or for long-term investments. However, if your planned expenses can be paid over the course of several months, you simply want access to credit, or the expenses are smaller overall, then a home equity line of credit is a better option than a home equity loan for business financing.

When to Use a Home Equity Line of Credit to Finance Your Business

A home equity line of credit is great for covering ongoing expenses such as inventory, payroll, and general operating costs. A HELOC is revolving, allowing you to borrow funds again once they are repaid, and you don’t have to pay any interest on unused funds. Keep in mind, however, that as the term of your HELOC approaches, it will convert into a term loan, at which point you can no longer borrow additional funds.

Some good opportunities to use a home equity line of credit to finance your business include:

• Inventory purchases: Restocking inventory is critical to any business that sells a product. However, how much inventory you need and how often you need to restock it is often unpredictable, so a home equity line of credit is a great option for inventory financing.
• Payroll financing: Although financing payroll expenses are more predictable, they usually don’t need to be financed in one lump sum. Borrowing as much as you need, when you need it, and only paying interest when you borrow is a key feature of a home equity line of credit.
• Operating costs: After some slow months, or immediately after an expansion, you may find your cash flow too tight to meet operating costs. Even if this isn’t happening right away, having a home equity line of credit available to borrow from in such an event can give you peace of mind to focus on your business.

Whether you need a working capital loan or would like to have access to a line of credit if you need it, a home equity line of credit can be a great source of funds for your business.

When to Use a ROBS as a HELOC Alternative

If you are starting or buying a business, and want to avoid interest payments and debt, you could utilize a rollover for business startups (ROBS). A ROBS allows you to use your retirement account like a 401(k) to fund your business without any penalties or interest. Typically, startups that use a ROBS provider for financing are more likely to succeed and stay in business, largely due to the reduced debt burden.

You will need at least $50,000 in retirement savings to make setting up a ROBS cost-effective. To set one up, you’ll form a new business and open a retirement plan. You then roll over your retirement savings into that plan and have it buy shares in your newly formed business. With this step completed, you will have access to the funds. However, there are several key rules that you need to follow in order to avoid any issues.

Although using a ROBS to finance your business has many advantages, setting one up can be complicated, and you risk being audited if it’s done incorrectly. This is why we recommend working with Guidant to set up your ROBS. It offers two free consultations with outside counsel who will answer any questions, so you can decide if a ROBS is a good option for your business.

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How to Use a Home Equity Line of Credit to Finance Your Business

A HELOC is a revolving line of credit secured by your home and works similar to a credit card. You get access to a specific sum of money for a particular period (called the “draw period,” typically five to 10 years) and you can draw on the money as needed. Like a credit card, as you pay back what you borrow, you can access those funds again.

HELOCs typically have a variable interest rate. This means your monthly payments will vary depending on the market rate at the time of the draw and on how much you borrow. There are two repayment periods for a HELOC. During the initial five- to 10-year draw period, you can withdraw funds from your line of credit, and minimum payments go to interest only. During the next 10 to 20 years, the HELOC becomes like a loan that you pay back, with higher monthly payments going toward principal and interest.

How to Use a Home Equity Loan to Finance Your Business

Unlike a HELOC, using a home equity loan to finance your business is similar to a term loan: it provides you with a lump sum of capital upfront. There is one repayment stage, with amortized payments, typically over 30 years, after you receive the loan. Rates are typically fixed, unlike a HELOC, which means you will have the same monthly payments over the course of the loan.

HELOC vs Home Equity Loan to Finance Your Business: APR

HELs and HELOCs 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%, and home equity line of credit rates range from 5% to 11%. HELOC rates are typically variable and are higher due to the risk of a revolving line of credit for the lender compared to a term loan.

APR on a HELOC to Finance Your Business

The rate you receive (between 5% and 11% APR for a home equity line of credit) will depend on your personal credit history, the lender you work with, and the current market rate. Your rate will adjust as often as monthly, but outstanding payments only need to be made on the amount that you borrow. APRs are calculated on a full year of interest, so by repaying your principal, HELOCs can potentially be a less expensive option than a home equity loan to finance your business.

APR on a HEL to Finance Your Business

In contrast to a home equity line of credit, a home equity loan typically has a fixed rate throughout the life of the loan. This rate ranges from 4% to 8%, and 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 debt-to-income ratio, you can receive a lower APR on the loan.

HELOC vs Home Equity Loan for Business Funding: Fees

The fees for a HEL and HELOC are included in the APR and can total as high as 6% for a HEL. However, a home equity line of credit charges smaller ongoing fees, up to $75 per year, with similar upfront closing fees of 2% to 5%. Both options also charge fees for closing an account early.

Fees on a HELOC for Business Purposes

With a home equity line of credit, there are information gathering fees to help your lender make a decision, similar to a home equity loan. Before approval, you will need to pay an application fee to apply and an appraisal fee to verify the value of your home. Once approved, there is a minimum draw amount, an annual fee, and additional transaction fees that will be charged to the account.

Some fees you will likely encounter when getting a home equity line of credit to finance your business are:

• Application fees: Up to $100
• Third-party closing costs: 2% to 5% of the loan amount (covers application processing, appraisal of home value, and so on)
• Annual fee: Up to $75, often waived for the first year
• Draw fee: Typically a small fee of $5 per draw or less
• Early termination fee: Up to $500

A HELOC typically has an annual fee, unlike a home equity loan. For both a HEL and a HELOC, you will need to pay third-party closing costs similar to a mortgage, including application processing, home appraisal, and recording fees. When you terminate your line of credit, you will be charged a fee based on the outstanding principal, typically no more than $500, whereas repaying a HEL early can cost you as much as 3% of the loan amount.

Fees on a Home Equity Loan for Business Purposes

A home equity loan has fees that are similar to most traditional loans. You will need to pay closing costs, which typically range from 2% to 5%, and origination fees up to 1% of the loan amount. These fees will typically be rolled into the total amount that you borrowed.

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 (covers application processing, appraisal of home value, and so on)
• Annual fee: None
• Draw fee: None
• Prepayment penalty: Up to 3% of the loan amount

Paying back debt early should be a good thing, but unfortunately, you can get hit with prepayment penalties or early closure fees. Remember, HELs and HELOCs are tied to home ownership, 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 or HELOC.

HELOC vs Home Equity Loan to Finance Your Business: Repayment Terms

With a home equity loan, you borrow a lump sum and repay it over the term of the loan (up to 30 years). However, a HELOC has a two-step repayment term. The first, typically lasting up to 10 years, requires interest-only payments, followed by a repayment period of up to 20 years that’s similar to a HEL. Both, however, offer longer repayment terms than traditional business loans, which typically don’t exceed 10 years.

Repayment Terms on a HELOC to Finance Your Business

A home equity line of credit requires repayment of principal and interest in two stages. In the first stage, the draw period, you can typically pay interest only on the amount you’ve drawn. If you don’t draw anything, then your payment is zero. Once the draw period is over in five to 10 years, you are required to make equal principal and interest payments amortized over the next 10 to 20 years.

HELOCs are a bit more complicated with two relevant time periods:

• Interest-only draw period (typically five to 10 years): During this period, you can withdraw funds from your credit line. Minimum monthly payments go toward interest only, though you can pay down principal in full by making larger monthly payments.
• Interest plus principal repayment period (typically 10 to 20 years): During the repayment period, you can no longer access any funds from your credit line. The HELOC becomes a term loan. You must pay back the principal balance of borrowed funds plus interest, so the monthly payments will be higher than during the draw period.

The risk of a home equity line of credit is that you may be unable to make the payments once the repayment period begins. To avoid this risk, it’s important to keep track of the amount of principal you have outstanding and pay it down when possible before the repayment period begins.

Mark Mitchell, Senior Vice President at TD Bank, explains:

“HELOCs requires the borrower to pay back interest only for the first several years of the term, and some borrowers do so only to find out that when the loan matures they can’t afford the payment, putting their personal and business credit in jeopardy.”

You can avoid this by planning ahead and setting aside extra cash as your repayment period nears. For example, it probably wouldn’t be wise to splurge on a fancy piece of equipment right before your repayment window begins.

Repayment Terms on a Home Equity Loan to Finance Your Business

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 ranges from approximately 10 to 30 years. Your payments will depend on the size of the loan, and it’s important to estimate exactly how much free cash flow is available to pay for interest to avoid risking your personal and business assets.

HELOC vs Home Equity Loan for Business Purposes: Qualifications

To qualify for a HEL or HELOC, you will need to meet personal credit score of 660 or greater, a debt-to-income ratio of 50% or less (43% or less with traditional lenders), and have at least 10% to 20% home equity. The credit score required is similar to traditional business loans, but they also require business information, which makes HELs and HELOCs good for startups.

Qualifying for a HELOC to Fund Your Business

Qualifying for a home equity line of credit to finance your business depends entirely on your personal qualifications and available home equity (at least 10% to 20%). This means that even if your business is brand-new or it is only generating a small amount of revenue, you can still qualify. You will still need to have great personal credit (660 or more) and be able to demonstrate a strong history of on-time payments as well as a good debt-to-income ratio up to 50%.

The qualifications you will need to meet to get a home equity line of credit to finance your business are:

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

The credit score requirement is higher for a home equity line of credit compared to a home equity loan. Besides your credit score, your debt-to-income ratio (DTI) is a major factor considered by the lender. To calculate your DTI, simply add all of your monthly debt expenses, including rent, credit cards, and car payments, and divide that by your monthly income.

Qualifying for a Home Equity Loan for Business to Fund Your Business

A home equity loan has similar qualifications to a home equity line of credit. In particular, the minimum credit score required by most lenders is 660. Sometimes you can qualify with a lower credit score for a home equity loan based on your income because you start making payments on the loan right away, unlike a HELOC.

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

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

There are some situations in which your credit score can be lower, but you will need to demonstrate that you have substantial income or savings that can be used to repay the loan. If this isn’t an option, you could also qualify for a personal loan for business funding.

HELOC vs Home Equity Loan to Finance Your Business: Loan Amount

For both a home equity loan and a home equity line of credit, you can borrow up to 80% to 90% of your combined loan-to-value ratio (CLTV). Although this is the maximum, it doesn’t mean that you should borrow this much. If you’re unsure exactly how much you need to borrow, a home equity line of credit can give you access to the maximum amount without the obligation of immediate repayment.

Loan Amount on a Home Equity Line of Credit to Finance Your Business

Most lenders allow you to borrow up to 80% to 90% of your CLTV. However, the loan amount is based on more than your CLTV—it’s also based on your ability to repay. The payments will often be amortized over 20 years, so you may qualify for more than you could with a home equity loan.

Using a HELOC to Finance Your Business Example

With a HELOC, you don’t pay interest on unused funds (unlike a HEL), so it’s often best to get the largest credit line that you qualify for. For example, a $100,000 credit line doesn’t cost more than a $10,000 credit line—the amount of money that you withdraw determines your cost. Having access to a larger credit line gives you greater flexibility in case your borrowing needs change over time.

Here’s an example of how much you’d be able to borrow:

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 line of credit to start a new business:

If you decide to choose a HEL instead of a HELOC, the maximum HEL amount would be the same based on the CLTV. However, the amount you qualify for might be different because the payments required on a HELOC are lower when it gets into the amortization period. Plus, during the draw period, which is typically 10 years, you only need to make interest payments on the amount outstanding.

Loan Amount on a Home Equity Loan to Finance Your Business

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. That being said, most banks have size minimums for HELs and won’t grant a HEL below $10,000.

Here’s an example of how much you’d be able to borrow:

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:

As you can tell, although the amount you can borrow is the same, because a HEL is amortized over 15 years, the payments are substantially higher. When your lender considers how much to lend, it will look at your ability to repay the loan with your current income. Having higher monthly payments with a HEL can reduce the amount that you are able to qualify for.

HELOC vs Home Equity Loan to Finance Your Business: Tax Treatment

When you use home equity to fund a business, you are investing personal funds in your business. As of 2018, the interest for this financing is not tax-deductible (unless it’s used to improve your home). For any specific tax questions, we recommend consulting a tax professional and discussing your specific financing situation with them.

William Perez, a Fit Small Business tax writer, indicates that:

“According to IRS Publication 936, Home Mortgage Interest Deduction, if the loan proceeds are used to buy, to build, or to substantially improve their main home or a second home, then the interest paid on such loans is tax-deductible on the first $1 million of loan principal. If the loan proceeds are not used to buy, build, or improve their home, however, then the interest paid on such loans is no longer tax-deductible starting with 2018.”

Although it used to be the case that you could always deduct the interest paid on a home equity loan, this changed as of 2018. With the new rules, if you are borrowing the funds and investing them in your business, you will be unable to deduct interest expenses. This can make the loan substantially more expensive and is worth discussing with a tax professional.

How to Get a HELOC or Home Equity Loan to Finance Your Business

You can get a home equity line of credit or 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 line of credit or 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.

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Home Equity Loan vs Line of Credit Pros & Cons

Using a home equity line of credit or home equity loan to finance your business can be an inexpensive alternative to traditional financing. It is tied to the value of your home and can potentially put your personal assets at risk, which is important to consider. However, if you need startup funding, a home equity loan can be one of the least expensive ways to finance your business.

Pros of Using a HELOC or HEL for Business Purposes

Some advantages of using a home equity line of credit or home equity loan to finance your business are:

• Less expensive than other financing options: HELs (4% to 8%) and HELOCs (5% to 11%) are less expensive than alternative business loans (30% to 50%), credit cards (15% to 25%), and virtually every other type of business financing. This is because they are secured by your home, making them less risky for the lender.
• Available for startups: HELs and HELOCs are especially useful for those seeking to start a new business because you are not required to present any details about your business for funding. This is great for businesses that have low or no revenue and need an early capital injection.
• No business collateral needed: A lot of business loans require collateral or a lien on business assets. A HEL or HELOC uses your home as collateral, which is a great option if you have little or no business assets available to pledge.

Cons of Using a HELOC or HEL for Business Purposes

Some risks of using a home equity line of credit or home equity loan to finance your business are:

• Your home is on the line: If you fall behind on payments, you could lose your home. This is because with a HEL or HELOC, you are pledging the equity in your home as collateral for the financing.
• Tied to home ownership: You can’t get a HEL or HELOC unless you’re a homeowner and have equity in your home. When you sell your home, you must pay off the HEL or HELOC in full with the proceeds of the sale. Selling too early could trigger prepayment penalties.
• Requires strong personal credit for approval: To get approved for a HEL or HELOC for business funding, you will need to have a personal credit score of at least 660. This can be difficult for borrowers with lower scores; such borrowers should consider different financing options (like a small business credit card).

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.

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Alternatives to Using HELOC or Home Equity Loan to Finance Your Business

Using a HELOC or home equity loan to finance your business can be a good option, particularly if you have good credit and sufficient equity in your home. However, if this isn’t the case, there are other business funding alternatives such as a ROBS, a personal loan, and business credit cards.

Some alternatives to using a home equity line of credit or home equity loan to finance your business are:

• Rollover for business startups (ROBS): With a ROBS, you can access your retirement savings and use them to fund a new business or business acquisition. Although it can be complicated, the best ROBS providers have the experience to set up a ROBS and make sure you meet all the necessary requirements so you can focus on your business.
• Personal loan for business: One of the requirements for getting a home equity line of credit is having a home with sufficient equity. If you don’t have a home to borrow against, you can still get a personal loan for business funding. Typically, you will need to have a good credit score and income to qualify, but it can be enough to cover early startup costs.
• Business credit cards: Although most business credit cards may be insufficient to entirely fund a startup, they can be a great way to smooth over some gaps in cash flow and provide the funds you need until you find additional financing. The best startup business credit cards even provide additional perks to their users, like cash back and rewards.

Regardless of whether you’re using your home, retirement savings, or simply your personal credit to obtain financing for your business, it’s important to recognize the risks inherent in this funding. Not all businesses succeed, and if your business fails, it’s important to have a contingency plan for repaying your debt to avoid losing your personal assets.

HELOC vs Home Equity Loans to Finance Your Business Frequently Asked Questions (FAQs)

Using a home equity line of credit or home equity loan to finance your business isn’t difficult, but it does tend to raise specific questions. We have addressed some of the most common questions below. If your question hasn’t been answered, feel free to share it with us in the Fit Small Business forum.

Some of the most frequently asked questions when it comes to using a home equity loan to finance your business are:

Do you need an appraisal to get a home equity loan?

An appraisal is required to get a home equity loan. However, if you purchased the house recently, your lender may use an existing appraisal, which it will request directly from your original lender. An appraisal may be considered valid for up to six months as long as it meets the regulatory requirements your lender must follow.

What happens if you don’t pay a home equity loan?

If you don’t pay a home equity loan or line of credit, your lender will likely pursue foreclosure on your home. In this case, a home equity loan or line of credit is similar to a mortgage. If you default, your lender can foreclose on your home to settle any outstanding debt.

Can the lender freeze my home equity line of credit?

If you obtain a HELOC, most plans allow the lender to freeze or lower your credit line if the value of your home “declines significantly” or if the lender “reasonably believes” you will be unable to pay back what you borrow due to a “material change” in your financial situation.

If the lender freezes your credit, you can speak to the lender and find out if there is any way to restore the line of credit. For instance, you may be able to provide documentation to prove that your home value has not “significantly declined” or that a “material change” in your financial situation was temporary.

Bottom Line

Home equity loans and lines of credit are inexpensive ways to finance your business. A HEL is best for predictable and one-time costs, and a HELOC is best for more variable or staggered expenses. 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.

One option you have for applying for a home equity loan or line of credit is LendingTree. Its online marketplace has many lenders allowing you to compare rates, offers, and find a good fit. Seeing your options takes a few minutes.

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