Business owners may consider using a home equity line of credit (HELOC) to pay for business expenses, but it’s important to consider the pros and cons of using a home equity loan. business purposes before making a decision.
A HELOC allows you to borrow money as needed, using the equity in your home as collateral. Since the loan is secured by your home, you may qualify for lower interest rates. However, using a HELOC for business purposes comes with risks, such as losses due to an uncertain business climate and the ramifications of putting your home equity at risk.
Is it a good idea to use a HELOC for my business?
If you can afford to repay the loan, using a HELOC for your business might be a good idea. You can get lower interest rates than you otherwise would, and revolving credit means you only need to borrow what’s needed.
Benefits of Using a HELOC for Business
- Easier to qualify for: Since a HELOC is a secured loan – using your home as collateral – the lender views the loan as less risky. For this reason, a HELOC is generally easier to obtain than an unsecured loan, which has no assets attached.
- Low interest rates: In March 2022, the average HELOC rate was 6.24%. This rate is much lower than the average rate for other types of debt. For example, during the same period, the average credit card rate was 16.34%.
- More flexible repayment periods: HELOCs come with draw periods that typically last 10 years. During this period, you can withdraw funds and only repay the interest on the amount borrowed. Once the drawdown period is over, you will typically have 15-20 years to repay principal and interest.
- Large quantities may be available: If you have a lot of equity in your home, you may be able to borrow a large amount of money with a HELOC. Some lenders will let you borrow up to 85% of your home’s combined loan-to-value ratio.
The risks of using a HELOC for businesses
- Variable interest rates: Although you may get a low interest rate initially because the interest rate is variable, it could increase in the future. This would increase your cost of borrowing. The unpredictable nature of the interest rate can make it difficult to create a repayment plan. Use a HELOC calculator to estimate how much your monthly payments might change if the rate goes up or down.
- Default risk: If your business goes bankrupt or you run into financial difficulty and you find yourself unable to repay the loan, the lender can foreclose on your home. It will also take a big hit to your credit score, making it harder for you to qualify for future loans.
Alternatives to Using a HELOC for Your Small Business
If you think using a HELOC isn’t a good idea for your small business, here are some alternative options to consider.
Home Equity Loan
A home equity loan is similar to a HELOC in that it is a loan secured by your home. Unlike a HELOC, it usually has a fixed interest rate and the funds are issued as a lump sum. If you choose this option, fixed monthly payments may be more suitable for your budget. Also, it has lower average interest rates than personal loans and credit cards.
Unlike home equity loans, personal loans are generally unsecured – the lender cannot seize your assets without a court’s permission. When a lender reviews your application, approval is highly dependent on factors such as your income, debt-to-equity ratio, and income. Although the length of the loan terms varies depending on the lender, it is generally between one and five years.
In March 2022, the average personal loan rate was 10.28%. However, the rates vary from 3% to 36%. The rate you get will depend on your credit score and other factors. Having a high credit score usually means getting a lower rate.
Small business line of credit
A business line of credit is a loan that works similar to a credit card and a HELOC in that you borrow money as needed. With this option, you can borrow only what you need for your business. Business lines of credit can be secured or unsecured, and interest rates vary between the two options.
Small business credit card
A small business credit card works like a regular credit card, but you use it for business expenses. If you pay off the balance on the card by the due date, you can avoid paying interest. Additionally, some small business cards come with interest-free periods that last up to 12 months. As long as you pay off the balance before the promotional period expires, you can avoid interest payments.
Secured or unsecured business loan
Another option you have for financing your business expenses is to take out a secured or unsecured business loan. When you take out a secured business loan, the lender will ask you to secure the loan with an asset. Although you can use a business asset – land, equipment, or a building – lenders will let you choose what type of collateral to pledge. An unsecured business loan does not require collateral.
To qualify for a small business loan, your business will need to meet the lender’s minimum requirements. For example, some lenders require that your business has been in existence for a certain number of years or generates a minimum amount of annual revenue.
The bottom line
When choosing between using a HELOC for business and other financing options, you should compare the interest rate and terms of each option, the loan amount, and the consequences of default on the ready. If you use a HELOC for business, you may be able to get a lower rate and higher loan amount than with other types of loans.
However, you must decide if the risk of potentially losing your home is worth it. If you decide that’s not the case, research other options.