How To Use a Home Equity Line of Credit to Fund Your Business
This article is part of a larger series on Business Financing.
For startups with a limited time in business or limited revenue, a home equity line of credit (HELOC) may be easier to qualify for than a business loan. Much like a business credit card, a HELOC gives you access to a line of credit that can be drawn against as long as there’s credit available. It’s best used for smaller, recurring business expenses.
Your local bank can provide a HELOC. If it already has a first mortgage on your property, it may offer discounts on fees and closing costs. If you aren’t sure where to go to get a HELOC, LendingTree is a great option. LendingTree’s marketplace allows you to compare rates and terms across many lenders. Check out its website for more information.
Step 1: Determine If You Are Eligible
Like any other personal loan for a business purpose, there are several factors lenders will consider when determining your eligibility for a HELOC. To be eligible for a home equity line of credit, you will need:
- A good credit score: Most lenders require a credit score of at least 660 to qualify for a HELOC.
- Equity in a primary residence: Lenders will allow you to borrow between 90% and 95% of the value of your home. For example, if your home is valued at $300,000, and the maximum loan to value (LTV) is 90%, the most you will be able to borrow between your first mortgage and HELOC is $270,000. Subtract your first mortgage balance to find out the maximum HELOC size allowed.
Keep in mind that if your combined loan to value 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 HELOC
If you’re eligible for a HELOC, you need to decide if you should use a HELOC to fund your business. Consider the terms, costs, and qualifications required for the line of credit, when it’s best to use a HELOC, and the pros and cons before proceeding.
Cost, Term, or Qualification for HELOC | Value |
|---|---|
Loan Amount | Up to 95% combined LTV |
Expected Annual Percentage Rate (APR) | From 4% to 8%, variable rate |
Closing Costs | From 2% to 5% |
Annual Fees | Varies |
Other Costs | Appraisal fees and application fees |
Repayment Term | A draw period of 10 years, with an option for renewal or entry into repayment period of up to 20 years |
Minimum Credit Score | 660 |
When to Use a Home Equity Line of Credit to Finance Your Business
The following are some excellent reasons for getting a HELOC to finance your business:
- Pay off more expensive debt: If your company has high-interest-rate debt, like a merchant cash advance or hard money loan, you can use your HELOC to pay those debts off and save money.
- Minor remodeling: If your office or storefront needs minor renovations, a HELOC can allow you to get the funding you need to get it done quickly and all at once.
- Use as an emergency fund: Just like a business credit card, a HELOC gives you access to a line of credit if an emergency expense arises.
- Large upfront startup costs: There may be items essential to the success of your startup, such as equipment, a storefront, signs, or initial inventory. A HELOC gives you access to startup capital which can be repaid once your business takes off.
Pros and Cons of a HELOC
| PROS | CONS |
|---|---|
| Less expensive than other financing options | Tied to homeownership |
| Available for startups | Your home is at risk if you default |
| No business collateral needed | Requires strong personal credit to qualify |
| Ability to borrow against available line of credit | Variable interest rate, which can rise over the life of the draw period |
| No restrictions on how funds are used | Easy to overextend and end up with large loan entering repayment period |
Step 3: Decide Between a HELOC and a HEL
While a HELOC is a revolving line of credit, a home equity loan (HEL) is a lump sum payment at closing which is paid back in monthly installments for up to 30 years. Interest rates on a HEL are fixed compared to the variable rates on a HELOC. As a HEL is repaid, it cannot be borrowed against. In most cases, if you qualify for a HELOC, you would qualify for a HEL.
When choosing between the two, a HEL is preferable for larger projects or when a lump sum of money is needed all at once. Also, if you want the certainty of a fully amortizing loan that will be repaid completely at the end of the term, choose a HEL.
Conversely, a HELOC is best for smaller, recurring expenses. It’s also best when you might need to borrow multiple times. This works well for a business with irregular income, like farming. A farmer can make large, lump-sum payments on the line of credit when they’re paid for crops and then borrow against it again until the next time they’re paid.
When considering the renewal of a HELOC, lenders prefer customers who use lines of credit and pay them down regularly. If a HELOC is maxed out with just minimum payments made, the lender will be less likely to approve a renewal. If you intend to use a HELOC this way, you should consider getting a HEL instead.
Terms | Home Equity Line of Credit | Home Equity Loan |
|---|---|---|
How Funds Are Received | Money borrowed as needed | Lump-sum disbursement |
Fixed or Variable Interest Rates | Variable interest rate based on the prime rate | Fixed interest rate |
Reborrowing Money | Can be borrowed again like a credit card | Cannot reborrow money as it is being repaid |
Loan Term | Usually, a draw period of up to 10 years, followed by a repayment period | Fully amortized repayment period of up to 30 years |
Used | Best for smaller, recurring expenses | Best for large and one-time expenses where a lump sum of money is needed upfront |
Step 4: Find the Right HELOC Provider
The best place to obtain a HELOC is the bank that holds the first mortgage on your property. They may offer discounts on fees and closing costs because they already hold a lien against your property. Also, some small lenders may not offer a second mortgage on a property if they don’t also have the first mortgage.
Top Home Equity Line of Credit Providers
Provider | Best For |
|---|---|
Your Local Bank | Potential rate and closing costs discounts, especially if your primary mortgage is held there |
Multiple loan offers to choose from with one application | |
A smaller HELOC starting as little as $15,000 | |
No application fees, closing costs or annual fees, and discounted rates for existing customers |
Interest rates between providers should be very similar because they’re based on the prime rate. HELOC interest rates are variable and will rise and fall with the prime rate. Usually, banks will adjust your rate on the first of the month after a prime rate change.
You won’t receive a loan estimate for a HELOC, but you should get a rate quote and a list of fees from your lender. Compare rates and fees across lenders to determine the best potential provider for your HELOC. Also, note if you’ll have to pay private mortgage insurance as this will raise your monthly payment.
If going to your local bank to get a HELOC isn’t an option for you, check out LendingTree. With one application through LendingTree’s marketplace, you can compare multiple offers from different lenders to make sure you get the best terms for your HELOC. Visit LendingTree’s website for more information.
Step 5: Apply for a HELOC and Preclosing Process
The application process for a HELOC is very straightforward and is done concurrently with step 4. You’ll need to fill out an application and provide at least two years of personal tax returns. You may also need bank statements and recent pay stubs.
Once you’re preapproved, the bank will order an appraisal and title work on your property. Once the lender gets the final appraisal and title work, a final truth-in-lending disclosure should be issued. The entire process should take between 30 and 45 days.
Step 6: Close the HELOC, Receive Access to the Line of Credit
After closing the line of credit, you’ll receive access to the HELOC 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’ll be able to access your line of credit. The line of credit can be used through mobile apps, checks, and cashier’s checks at your bank.
Alternatives to HELOC To Fund Your Business
If you decide that a home equity line of credit isn’t the best choice for financing your business, there are many other options for startup business financing. Check out our guide to getting a small business loan before exploring your alternatives.
Five alternatives to a HELOC to fund your business include:
- Rollover for business startups (ROBS): If you have at least $50,000 in personal retirement funds to invest, a ROBS can be a great choice. It can be very complicated, so check out our guide and consult your financial advisor before proceeding.
- Small Business Administration (SBA) loan: Companies with good credit and a solid business plan that don’t need funds quickly can use a loan backed by the SBA. SBA Microloans are great choices for startup funding.
- Business credit cards: If you need a line of credit but can qualify for one with your business, a business credit card can give you quick access to funds.
- Equipment financing: If you need a piece of equipment that is crucial to the early success of your business, equipment financing is a great choice.
- Crowdfunding: This is an excellent option for startups with a strong brand or dedicated customer following and little to no revenue.
Bottom Line
Using a HELOC to obtain a revolving line of credit is a great way to fund a startup business. Since it relies on your personal credit, income, and homeownership, you don’t have to worry if your company hasn’t been operating long enough or doesn’t have enough revenue to qualify for a business loan. Before considering a HELOC, remember that your home will be at risk should you default on this type of loan. If that’s a risk you don’t want to take, other great startup business financing alternatives are available.
