How to Use a Home Equity Loan to Finance Your Business
This article is part of a larger series on Business Financing.
A home equity loan (HEL) may be easier to get than other types of startup financing. If you have equity in your primary residence and strong personal credit, you can use a HEL for one-time expenses or needed capital influx into the business.
Your local bank can provide a HEL. If it already has your first mortgage on your property, it may offer discounts on fees and closing costs. If you aren’t sure where else to get a home equity loan, LendingTree is an excellent option. It is a marketplace that allows you to compare rates among many lenders. Check out its website for more information.
Follow the six steps below to get a home equity business loan.
Step 1: Determine If You Are Eligible
When considering any personal loan for a business purpose, you have to determine a few things. To get a home equity loan, you must have
- A good credit score: You will likely need a credit score of 660 or greater to qualify for a HEL.
- Equity in a primary residence: Providers will usually lend up to between 90% and 95% of the value of your home. For example, with a home valued at $200,000, and the maximum loan to value of 90%, the most lenders will allow you to borrow between your first mortgage and your HEL is $180,000. Subtract the balance of your first mortgage to find out the maximum size allowed of a home equity loan.
Keep in mind that if your combined loan to value (LTV) ratio ends up above 80%, you may have to pay private mortgage insurance, which will raise your monthly payment.
Step 2: Figure Out If You Should Use a Home Equity Loan
Once you have determined that you are eligible to get a home equity loan to fund your business, you need to decide whether you should. Consider the terms, costs, and qualifications needed for the loan, when it is best to use a HEL, and the pros and cons of using it to fund your business before proceeding.
Cost, Term, or Qualification for HEL | Value |
|---|---|
Loan Amount | Up to 95% combined LTV |
Expected Annual Percentage Rate (APR) | From 4% to 8% |
Closing Costs | From 2% to 5% |
Annual Fees | Varies |
Other Costs | Appraisal fees, application fees |
Repayment Term | Up to 30 years |
Minimum Credit Score | 660 |
When to Use a Home Equity Loan to Finance Your Business
The following are some excellent examples of when it is best to get a HEL to finance your business:
- Equipment purchases: The interest rate on a HEL is usually lower than an equipment loan. Also, if your business is a startup, you might not have the financial history needed to qualify for an equipment loan. You can use a home equity loan instead.
- Major remodeling: If your office or storefront needs major remodeling, a HEL can allow you to get the funding you need to get it done quickly and all at once.
- Business acquisition: Using a HEL can give you the funds needed as a down payment on a loan to buy a business.
- Opening a new location: Because the upfront costs of opening a new location can be high, you can use the money from a HEL to cover some of those initial costs.
- Large upfront startup costs: There may be certain items that are essential to the success of your startup, such as equipment, a storefront, signs, or initial inventory. A HEL gives you the capital to get your business off the ground.
Pros and Cons of a HEL
| PROS | CONS |
|---|---|
| Less expensive than other financing options | Tied to home ownership |
| Available for startups | Your home is at risk if you default |
| No business collateral needed | Requires strong personal credit to qualify |
| Low interest rates, long repayment term | Higher upfront costs than other types of loans |
Step 3: Decide Between a HEL vs HELOC
Unlike a home equity line of credit (HELOC), where you get a line of credit that can be used as needed, a HEL is paid out in one lump sum at closing and is paid back in monthly installments for up to 30 years. Interest rates on a HEL are usually fixed compared to variable rates on a HELOC. In most cases, if you qualify for a HEL, you will also qualify for a home equity line of credit.
Home Equity Loan | Home Equity Line of Credit |
|---|---|
Lump sum disbursement | Line of credit means you borrow money only as you need it |
Fixed interest rate | Variable interest rate based on the prime rate |
Cannot reborrow money as it is being repaid | As you pay back the money, it can be borrowed again like a credit card |
Fully amortized repayment period of up to 30 years | Usually a draw period of up to 10 years, followed by a repayment period |
Best for large and one-time expenses where a lump sum of money is needed upfront | Best for smaller, recurring expenses |
Step 4: Find the Right Home Equity Loan Provider
If you have a local bank you use regularly, it is a good place to start. If you get a HEL from the bank that has your first mortgage, you might even save money on closing costs. Also, some small lenders might not offer a second mortgage on a property where they do not also have the first mortgage.
Because interest rates are still very low, depending on the current interest rate on your primary mortgage, your lender may also discuss refinancing your first mortgage with cash out instead of just a second mortgage.
Because it is a mortgage on a primary residence, your lender will be required to provide loan estimates for any potential transaction. Compare costs involved with any potential transaction before agreeing to move forward, and be sure to know whether private mortgage insurance will be added to your monthly payment as that can increase your payments dramatically.
Step 5: Apply for a Home Equity Loan
You will need at least two years of personal income taxes to qualify. Once you are preapproved, an appraisal will be ordered on your property, and title work will be ordered. Once the lender receives the final appraisal and title work, a final closing disclosure will be issued no later than three days prior to closing. The entire process will usually take anywhere from 30 to 45 days.
Step 6: Close the Loan, Receive Funds & Begin Repayment
Once you close the loan, the funds will be received after the required right of rescission period expires. You have up to three business days to cancel the transaction. If you don’t cancel, you will receive your funds and will begin paying the loan back monthly until the loan is satisfied.
Alternatives to Home Equity Loans to Finance Your Business
If you decide that a home equity loan isn’t the best option for financing your business, there are other alternatives for startup business financing. The requirements for how to get a small business loan will differ from the ones for a personal loan like a HEL.
Alternative | Best for |
|---|---|
Business owners willing to invest retirement funds of $50,000 or more | |
Companies with good credit and a solid business plan that don’t need funds quickly | |
Business owners good at repaying debt and who want quick access to funds | |
Businesses where a major startup cost is purchasing equipment with a long life | |
Startup businesses with a strong brand or dedicated customer following and little-to-no revenue |
Bottom Line
A HEL is a great way to obtain a lump sum of financing to help with large and one-time expenses your business might have. If you need financing for your business and have a personal residence with built-in equity and a strong personal credit score, getting a HEL may be the best option. Before pursuing a HEL, be sure to consider that your home will be at risk—should you default on this type of loan. If that risk is too great, check out some alternatives to HELs to finance your business.
