Finding money to start your own company can be challenging, especially since lenders can be wary of loaning large sums to brand-new businesses, and small business grant programs are often highly competitive. As a result, you may need to get creative with your business financing options – and that could include tapping into your home equity.
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A home equity line of credit (HELOC) allows you to borrow money as you need it at a relatively lower interest rate. Based on the size of your equity stake in your home (the amount you own outright, that isn’t mortgaged), the funds can be used for virtually any reason. Financing a business with a HELOC, however, can come with risks, such as losses due to an uncertain business climate, a rise in interest rates and the ramifications of putting your home on the line.
Home Equity
Business financing statistics
Just 4 percent of small business owners rely on home equity for start-up financing, according to the Federal Reserve. Other sources include savings, start-up 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 in 2021, according to the Federal Reserve.
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The average homeowner had $270,000 in available home equity as of December 2022, according to CoreLogic.
The average cost of starting a small business ranges significantly depending on the industry. For example, launching an entertainment business costs an average of $12,272, while starting a restaurant costs around $375,000. Cost figures cover all types of operational expenses, including the business’s physical space, hiring, insurance, licensing and marketing.
Small business loans start at around $5,000, but the average small business loan amount is $663,000, according to the Federal Reserve.
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.
Unfortunately, small business failures are common: 18 percent fail after their first year in business, 50 percent fail after five years and 65 percent fail after a decade.
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Pros and cons to using a home equity loan for a business
If you’ve built up a good amount of equity in your home and can afford to repay it, using a HELOC for your business could make sense. You might get more favorable rates than with other products, 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 it less of a risk. As a result, a HELOC is usually easier to qualify for than an unsecured personal loan, which doesn’t have an asset backing it.
More flexible repayment periods: HELOCs come with draw periods that usually last 10 years. During this time, you can withdraw funds as needed and only need to repay interest on the amount you borrow (though you can pay the principal too). Once the draw period ends, you’ll typically have 15 years to 20 years to repay the principal and interest.
Large amounts might be available: If you have a significant amount of equity in your home, you might be able to borrow a substantial 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.
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More competitive interest rates: HELOCs tend to have lower interest rates than some other popular types of funding, including credit cards and personal loans. They may also have better rates than small business loans, depending on the loan type, lender and your financial profile.
Cons of using a HELOC for business
Variable interest rates: HELOC rates fluctuate. Although you might secure a low rate initially, it could rise in the future. This would cause your borrowing cost to increase and your monthly payments to rise, making it hard to create a predictable repayment plan or anticipate outlays. A HELOC calculator can help you 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 can’t repay the loan, the lender can foreclose on your home. This will also negatively impact your credit score, making it harder for you to qualify for future loans.
Interest isn’t tax-deductible: When you use a home equity line of credit to “buy, build or substantially improve” the residence that’s being used to secure the HELOC, the interest is tax-deductible. Using a HELOC for any other purpose – including starting a business – means that you won’t qualify for the deduction.
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Average HELOC rates
Other financing options for a small business
Home equity loan
A home equity loan is similar to a HELOC in that it is secured, or backed, by your home, and the amount you can borrow is based on your ownership stake. Unlike a HELOC, however, it usually has a fixed interest rate and the funds are issued as a lump sum – so you’ll need to pay back the entire loan balance (in fixed monthly installments), even if you don’t use it all for your business. Home equity loans also have lower average interest rates than personal loans and credit cards.
Personal loan
Unlike home equity loans and HELOCs, personal loans are usually unsecured — meaning that there’s no collateral backing them. The good news is, that means the lender can’t seize your assets without a court’s permission. The bad news is, the interest rates are often higher — compensating the lender for its greater risk — and so qualifying might be tougher. 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 for a personal loan is usually from one year to five years, which is much shorter than a HELOC term.
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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. But unlike home equity lines of credit, 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 at certain times — 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 personal credit card, but you use it for corporate expenses (it often comes with a higher credit limit than a personal card). 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 won’t pay any interest on your purchases.
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 a corporate asset, which can include land, equipment or a building. An unsecured business loan doesn’t require collateral.
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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.
Final word on using a HELOC for your business
When choosing between using a HELOC vs other financing vehicles, compare the interest rate and terms of each option, the loan amount and the consequences for defaulting on the loan.
HELOCs hold many advantages for small business owners: You might be able to secure a lower rate and a larger loan amount than with other types of loans, and, since withdrawals are flexible, you avoid saddling your company with debt it doesn’t need. But keep in mind that fluctuating monthly payments can hurt your credit if interest rates rise dramatically, and you suddenly find you’re unable to afford them. And of course, if the risk of potentially losing your home is worth it.
Business and home equity FAQ
How long does it take to get a HELOC?
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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.
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How often can the interest rate change on a HELOC?
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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 adjustments to interest rates it offers to financial institutions. The frequency depends on your specific line of credit; some HELOCs adjust once a month.
What is the draw period on a HELOC?Caret DownThe 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.
How does a HELOC affect your credit score?
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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, timely payments on your HELOC can help your credit score; missed payments will lower your score.
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How can you pay off a HELOC faster?
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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.
