Funding a business is inherently risky. Using home equity to fund the business may require that you put up your home as collateral.
Each type of home equity product offers distinct benefits and disadvantages. Compare each with traditional options, such as small business loans and business lines of credit.
Different lenders or service providers cap the amount of equity you may access at different percentages; commonly, it’s 80% to 90%.
Starting a new business (or funding an established one) can be one of the most rewarding – and challenging – endeavors you undertake. When it comes to funding the business, homeowners may be able to access home equity instead of taking on traditional loans.
Accessing home equity to fund a business provides particular benefits. These may include lower interest rates, easier qualification standards and higher loan limits. However, accessing home equity through a home equity loan (HEL) or home equity line of credit (HELOC) requires you to use your home as collateral. Another, non-loan, option, is a home equity agreement.
Using home equity to fund a business is an option only available to homeowners. Most homeowners finance their homes by obtaining a mortgage. They establish equity by paying down the mortgage balance and/or realizing appreciation, thus increasing the proportion of the home they own outright versus the amount still encumbered by the mortgage.
WATCH: How to Get Equity Out Of Your Home - 4 ways
Once you establish equity, lenders and other financial service providers provide products that allow you to access that equity and put it to productive use.
Whether using home equity is right for you depends on a range of factors, such as:
Amount of equity accessible
Credit score and history
Like some personal loans, home equity lenders don’t control how you use the funds derived from your home equity. However, using home equity to fund a business comes with risk, especially when you use your home as collateral.
Funding a business through home equity does have its advantages, though. First, it’s easier to satisfy the lender’s requirements. With your home as collateral, the lender considers the loan less risky.
Second, you may be able to access more funds – depending on the amount of equity in your home. For example, most home equity lenders allow homeowners to access about 85% of their equity. Imagine your home is worth $500,000 with an outstanding mortgage balance of $300,000. In this case, you have $200,000 in equity, with 85% of that amount, or $170,000, accessible.
Third, home equity products typically come with lower interest rates. The average rate for a home equity line of credit (HELOC) in April 2022, for instance, was 3.99%.
Finally, home equity products have a longer repayment period than business loans, personal loans and other installment loans. Most HELOCs carry a 10- or 20-year term, while home equity loans carry a 15- or 30-year term, like most mortgages.
If you’re considering using home equity to fund a business, learn about each option and compare offers from different providers.
1. Home equity loan
One of the most common home equity products is the home equity loan (HEL). Like other installment loans, the HEL provides a lump sum.
The HEL is basically a second mortgage that carries a fixed interest rate. The payments are predictable and are helpful for those who need a large, one-time lump sum. In some circumstances, the interest payments are also tax-deductible.
But as a second mortgage, your home will serve as collateral.
A HELOC works like a credit card. Again, your home serves as collateral. Unlike a HEL, a HELOC interest rate is variable, which means it could go up in the future.
With a HELOC, you can withdraw money during the “draw” period, which usually lasts 10 years. Once the draw period ends, you then make monthly payments to repay the amount you drew.
A HELOC works best if your business needs money for smaller, ongoing expenses.
3. Home equity agreement
As opposed to the HEL and HELOC, a home equity agreement is like an investment in your home. The service provider does not require your home as collateral. Rather, you receive funds in exchange for an interest in your home’s future value.
The home equity agreement is not a loan. You accrue no monthly interest and don’t have to make monthly payments. You can buy out the provider’s interest or sell the home to end the agreement.
When starting a business, the home equity agreement may prove a less-risky financing option because you would not lose your home if the business fails.
4. Cash-out refinance
The cash-out refinance is another option similar to a second mortgage. However, the cash-out refinance is a new mortgage that pays off the existing one. The new mortgage has a larger balance than what you owed on the old mortgage. The difference between the two is what you can use to fund your business.
Like the other options, cash-out refinance providers allow you to access up to 80% of your home’s equity. While interest rates are usually lower, you can expect prepayment penalties and cancellation fees.
When your business needs capital, you have options. Business loans, personal loans and credit cards carry high-interest rates and low loan limits. Accessing home equity can be a better strategy. If you’ve established equity in your home and want to tap in – without taking out a loan – choose Unlock Technologies' home equity agreement.
Contact us today to get started.
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