When it comes to using a home equity loan to finance new business ventures, there are generally two schools of thought. Some people think essentially betting your house on your business demonstrates the highest level of commitment to making your company a success. Others think it is simply too chancy to risk your personal assets in this way.
No matter what your opinion, the fact is that more entrepreneurs are tapping their home equity for their business. The New York Times cited a study by Barlow Research Associates that found in 2006, the percentage of small business owners using home equity for their business grew to 27.5 percent from 18.4 percent in 2001.
Typically, home equity loans come at a lower interest rate and are far easier to attain than any alternative. This makes them especially tempting to new entrepreneurs. Additionally, many lenders require business loans be backed with personal collateral like home equity if it is available, including the Small Business Administration 7(a) loan program, which is one of the most popular small business lending programs today. Since it's close to impossible for a new business to operate without the owner personally backing it in some way, many feel they might as well pursue a home equity loan for simple access to cash.
Is a Home Equity Loan Right for My New Business?
If you are hoping to finance new business endeavors with a home equity loan, there are a few things to consider. First, understand that a home equity loan is given in a lump sum, which you will pay back over an agreed-upon term with a fixed interest rate. As long as your home has increased in value since you purchased it, you will easily find a lender willing to offer you a home equity loan. For a home equity loan to work to your best advantage, you need to borrow during a time of stable interest rates and rising home values. Talk with your accountant or another trusted financial advisor to determine the economic climate in your area and how it could be impacted by global matters. Be sure to consider the following factors, outlined in Entrepreneur:
- How much is property appreciating in your area on average? Is it enough to offset the cost of your business investment?
- Will your business investment deliver a greater return than you'll be paying for the loan?
- Will you be able to service the debt from a cash flow perspective even if the business encounters challenges?
- How much other debt do you have? Significant debt from things like credit cards or car loans might impact the rate you pay on your home equity loan, which can cut your potential investment profit.
- How will the taxes from the loan play into your financial planning? Generally, the interest on home equity loans is not tax-deductible if used to finance a business, whereas interest on a small business loan is usually tax-deductible.
- What is your plan if you need emergency cash? Do you have another option if your home equity is already tapped?
While using home equity to finance new business ventures is a good option for many, some entrepreneurs are just too averse to gambling with their personal assets. Like any investment, you will have to determine if the potential reward outweighs the risks before making this important decision.