The experience of starting your own business is full of opportunities, challenges and even more challenges. But to do so requires money and lots of it. Did you know that you can use your home equity to fund a small business venture? In this article, we’re going discuss the pros and cons of such a strategy.
Home equity loans have become more popular as property values across the country have increased in the past two years. Since 2007, the use of home equity loans (also known as HELOCs, or home equity line of credit) has been at its highest. They are a risky way to finance new businesses.
Danny Papadopoulis, a mortgage broker with Homebase Mortgages in Toronto, is an expert on Home Equity Loans. Even entrepreneurs who are successful in their businesses face the risk of failure, says Papadopoulis. Do you want your roof or your house to be your only source of security?
What is home equity?
The difference between what you owe on your mortgage and how much your home is worth today is your equity. Your home equity can be calculated by subtracting the mortgage balance from the current value of your house. Home equity is created by paying off your mortgage consistently over time.
You will be required to repay the money borrowed plus interest if you borrow against your equity. If you do not pay back your loan and your business fails, you could lose your house.
Home equity loans can be used to improve or renovate your home and increase its value. They can also be used to pay off high-interest credit card debt, cover college tuition or start a business.
The two most common types of home loans are HELOCs and home equity loans.
Home equity loan: A home equity loan is an amount of money you receive with a fixed rate of interest. You’ll receive the entire amount of your loan upfront and can expect to pay predictable monthly payments throughout your loan.
HELOC A line of credit that is open, the HELOC functions more like a debit card. You can withdraw as much money as you want from your HELOC (you don’t receive the full loan upfront). HELOCs are subject to variable interest rates that can change depending on the economy. You should expect your monthly payment to fluctuate. HELOCs let you pay only interest for the first 10 years of your loan. The “draw period” keeps your monthly payment low.
Why is a home equity loan a good way to fund the launch of a business?
Due to their large limits and long repayment periods, home equity loans can be a great option for funding your business. You have more flexibility to repay the loan.
You will qualify quickly: If you have good credit, a debt-to-income ratio (DTI), and a DTI between 35-43%, then you can easily qualify for an equity mortgage loan.
High loan limit: The value of your property may be able to secure a higher loan limit than a credit card or unsecured personal loan. Your home equity will determine the amount of your loan.
Lower interest rates: Since your home serves as collateral for the loan, lenders can offer lower interest rates than on credit cards and other unsecured loans. Bankrate reports that home equity loans average 7.77% while HELOCs are averaging 7.31%.
Loan payment period: By extending the repayment period of your loan, you can have greater budget flexibility. You will also have lower monthly payments.
A home equity line can be a risky business start-up option
It’s not wise to use your house as collateral for an unreliable business. The rates on home equity loans have increased in the past year, making them less appealing.
AJ Makkunel is a Home Equity Specialist at Mortgage Central Nationwide and warns that home equity loan are no longer a viable source of financing. He points out that HELOC rates are at their highest level in 15 years. McBride says that as prime rates rise above 7%, the variable rate is likely to increase. The cost of borrowing has increased and the economic uncertainty has also increased. He thinks that is a bad mix.
A home equity line is not the best idea to start a business for several reasons.
By choosing this option, you put your home in danger. It is the riskiest way to finance. Why put your home at risk when you can have high credit limits on a business or personal card?
Borrowing from home equity will not increase your business credit score: Business credit is measured the same way as personal credit, and how well you can repay a loan.
You need exceptional credit to qualify for the lowest rate: A home equity loan may cost more if your credit score (FICO 800-850) isn’t exceptional or if you don’t have very good credit (740-799). Only homeowners with exceptional credit are eligible for the best rates. It is important to ensure that you are getting the best terms and rates for your home equity loan. It is not worth putting your roof at risk if you do not.
HELOC interest rates are variable. Variable rates are not beneficial in a rising rates environment, such as the one we have today.
Case Study #1: Urban Tail Toronto Dog Walkers
Lori Blair, owner of Urban Tail Toronto Dog Walkers chose a home equity to fund her business several years ago. “I considered business loans, personal loan and even a credit card for my business, but a home equity was the best option”.
Lori’s business has grown into one of Toronto’s most successful pet and dog services businesses with multiple locations in downtown Toronto.
A home equity loan changed my life. It allowed me take the equity that I have built up in my home and put it to use, helping my company grow exponentially over these last three years. It was one of the best decisions I made for my business”.
Case Study #2: Ahmad Karzai Law
Ahmad Karzai is the owner of Ahmad Karzai Professional Corporation, a criminal law firm located in Toronto and Brampton, Ontario. “I worked for a popular lawyer in Toronto for years, before branching out and starting my own law firm. In hindsight, using my homes equity to help fund my frist year of business was one of the best business decisions I’ve made to date”.
Ahmad Karzai Law is one of Toronto’s leading criminal law firms, specializing in DUI/Impaired Driving, Bail Hearings and many other criminal matters.
The Bottom Line
Avoid a HELOC if you can. It’s likely that your new business will fail if you are just starting it. It is better to use your house as collateral when applying for a credit card or loan.
