Key takeaways
- HELOCs are secured loans, offering more flexible repayment periods and competitive interest rates than many other types of business financing.
- The main disadvantage of HELOCs is that if you default on payments, your lender could take your home.
- If a HELOC isn’t right for you, other financing options for a small business could include a home equity loan, business line of credit or business credit card.
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.
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. If you’ve built up a good amount of equity in your home, using a HELOC to advance your business could make sense. The terms are often more favorable than those of a business loan and the rotating credit means you only need to borrow what is necessary. However, there are significant caveats to using a HELOC too, such as losses due to an uncertain business climate, a rise in interest rates and the ramifications of putting your home on the line.
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.
- The average homeowner had $274,000 in available home equity as of Q1 2023, 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.
How does using a HELOC for a business work?
If your lender approves you for a HELOC, you’ll have what’s called a draw period. Usually, this lasts 10 years and gives you the ability to withdraw money you need at any time to fund business expenditures such as new equipment, supplies/materials or office space up to your credit limit. It’s somewhat akin to a giant credit card: You can draw against the credit line, repay the funds, and then borrow them again. You’ll make monthly payments on the HELOC, which can be just a minimal sum — the interest on the amount you’ve withdrawn.
Once the draw period ends, you’ll enter the repayment period. This term generally lasts 20 years, and it’s where you’ll make payments on the principal and interest of your loan balance, at an amortized rate. You will no longer be able to borrow funds.
You apply and are approved for a HELOC as a home-owning individual, not in your guise as business owner/proprietor. To qualify, you generally need to have at least 15 to 20 percent equity stake in your home and a debt-to-income ratio of less than 43 percent. Other aspects of your financial profile — credit score, assets and the appraised value of your residence — will factor into the terms of your HELOC as well.
In contrast, with business loans, your personal finances and credit history may be considered — especially with start-ups and young enterprises — but the lender’s focus will be on your company. You’ll supply your business’s data and financials, including its tax ID, operating revenue, expenses, profit and loss statements, projections.
Business loans can be secured or unsecured (backed by collateral). If you’re going for a secured one (which has more favorable interest rates), approval would be contingent upon collateral, as well as revenue, length of business and credit history. The collateral would be related to the business too: equipment, accounts receivable, inventory, real estate or property.
Pros and cons of using a HELOC for business
Using a HELOC for a business carries several advantages, especially if yours is a start-up operation with few assets. Financing a business with a HELOC, however, also carries considerable risks, as well.
Pros of using a HELOC for business
- Easier to get: 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 often easier to qualify for than an unsecured loan, which doesn’t have an asset backing it.
- Flexible repayment: HELOCs come with draw periods that usually last 10 years. Once the draw period ends, you’ll typically have 15 years to 20 years to repay.
- 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.
- 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.
- Regulatory protections: HELOCs are subject to the requirements of the Truth in Lending Act (TILA), aka Regulation Z, which mandates certain disclosures by the lender, allows for a cooling-off period after signing up, and offers other consumer protections against predatory lending practices. In contrast, business loans are not bound by TILA.
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.
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. A home equity loan for business also has 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.
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.
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 — not to mention your budget — if interest rates rise dramatically, and you suddenly find you’re unable to afford them. And of course, you must consider if the risk of potentially losing your home is worth it to get your business off the ground.
Business and home equity FAQ
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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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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.
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The 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.
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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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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.
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