Should You Access Home Equity for Business Funding?

Key takeaways

• Traditional sources of financing for new businesses include small-business loans, personal savings, and loans from friends and family. These options may be unattractive because of the application process or the impropriety of asking family.

• If you’re a homeowner, you may consider using a home equity loan or home equity line of credit for business funding. During the past few years, home prices have soared, and your home equity may have grown.

• A home equity agreement – a no-loan option – is another way of accessing home equity when you want to start a new business.

The American economy thrives on innovation. Many innovative technologies have come from new businesses.

Starting a new business is exciting and hopeful. The U.S. Census Bureau estimated that in April 2022 alone, Americans filed 420,000 applications for new businesses. However, securing funding for a new business is a challenge all entrepreneurs must face.

With rising home prices, you may consider using home equity for business purposes. This can be a better option than traditional funding strategies for many people.

Starting a new business: thrilling and stressful all at once

The path to self-employment is difficult. Having a detailed business plan will help, but all of the planning in the world doesn’t guarantee that the business will succeed.

Twenty percent of new businesses fail in their first year. Even more disheartening is that 65% of new businesses go under in their first decade. These statistics don’t mean your business idea won’t succeed , but they do show that starting a new business venture is risky. That’s why you should cautiously evaluate every financing option when it’s time to find funding.

In a typical scenario, someone wishing to start a new business seeks funding from traditional sources. These include small-business loans, personal savings, and loans from family and friends. These options won’t work for every potential new business owner, however,

Take the small-business loan, for example. Risk-averse banks understandably view applicants for small-business loans as uncertain ventures. They, therefore, impose stricter qualification requirements, such as:

• Higher credit scores

• Proof of a minimum monthly or annual revenue

• At least two years in business

• A detailed business plan and loan proposal

Depending on your business idea, satisfying these requirements may be difficult or impossible. However, accessing home equity for business purposes may be easier.

Using home equity for business purposes

Home values have risen dramatically in recent years. From Quarter 1 of 2012 to Quarter 1 of 2022, the average U.S. home price rose by almost 80%.

This means that the value of your home equity may have risen as well.

First, note that home equity is the difference between your home’s current value and what you owe on the home. This means that for a home valued at $400,000, with a total mortgage balance of $200,000, you have $200,000 in equity. If your home’s value increased to $450,000 with the same loan balance, you’d have home equity of $250,000.

There are several ways to access home equity:

• Selling your home and using the proceeds

• Cash-out refinance

• Home equity loan

• Home equity line of credit (HELOC)

• Home equity agreement (HEA)

In any of these scenarios, you could use the money you extract from your home’s value toward your new business.

How a home equity loan works

A home equity loan functions similarly to a personal loan.

The lender – usually a traditional bank – provides a one-time lump-sum payment that you can use for any purpose. After receiving the money, you repay the debt in monthly payments with interest.

How a home equity line of credit (HELOC) works

A HELOC works like a credit card attached to your home’s value. You draw money from the line of credit for some time (the draw period) and then repay it once the draw period closes. As with a home equity loan, it also works as a loan, so you’ll repay interest.

Lenders view these types of loan as less risky than a small-business loan because your home secures the loan. If you default on the loan, the lender can foreclose on your house. However, it also means that qualification criteria are usually less strict.

You may also get a more favorable interest rate for these same reasons.

To qualify for a home equity loan or home equity line of credit, lenders usually look for:

• Sufficient income to repay the loan on time

• A credit score of at least 620

• At least 15% to 20% equity in your home

• A low debt-to-income ratio

Are these loans for business purposes a good idea?

Even if you do have sufficient home equity to obtain a home equity loan, whether you should use a home equity loan or home equity line of credit for business purposes is a different question.

A major consideration is that your home is collateral for the loan. This could be one of the most important factors because you could potentially lose your home if your business fails.

Not all businesses are equally risky. Research businesses in your industry with a higher success rate when determining how to finance your enterprise. For instance, a business that is more likely to be successful may cause you to view a home equity-based loan more favorably.

Similarly, you can research whether the proposed use of your loan is more or less risky. For example, maybe you’ll use the loan proceeds to purchase inventory. Using the proceeds for inventory that may spoil or become redundant is much riskier than purchasing inventory that retains its value over time.

Start a business with a home equity agreement from Unlock Technologies

No matter your business type, there is some inherent risk. That may make you uncomfortable using a loan-based product for business purposes. Another option is to use a home equity agreement (HEA) from Unlock Technologies.

Unlike the home equity loan, a HEA is not a loan. There are never any monthly payments, and your home is not collateral. Instead, you get a lump sum of cash in exchange for a percentage of your home’s future value.

If you think a HEA may be right for you, contact us at Unlock Technologies today.