Finance
February 2, 2024
If you’re looking to get your small business running or sustained, learn how you can use a HELOC for your small business expenses below!
If someone asked you what the best parts of starting a small business are, what would your answer be? Do you love the brainstorming part, where you write down all of your exciting ideas? Or are you the type of person who really enjoys developing a business plan?
Either way, it’s a pretty safe bet that your first answer wasn’t “figuring out how to get the money.” Life is expensive enough as it is, and even the smallest micro-businesses usually take between $1,000 and $5,000 to get off the ground, according to the US Small Business Administration.
So where do you look? If you’re a homeowner, you could literally be sitting on the money that you need. All you have to do is get access to your equity.
Tapping Your Equity – Home Equity Loans and HELOCs
You have two basic options for borrowing against your equity – a home equity loan and a home equity line of credit, or HELOC.
A home equity loan is probably what you think of when you picture a second mortgage. You get approval to borrow a certain amount of your equity and receive it as a lump sum. As a borrower, you pay that money back, plus interest, with a fixed monthly payment.
A home equity line of credit, usually called a HELOC, works more like a credit card. Your lender still approves you to borrow a certain amount, but instead of getting it all at once, you get a line of credit that you can draw from when you need money.
Using a HELOC to Start a Business
A HELOC can be better than a fixed home equity loan for a new small business owner. The expenses of starting a small business don’t crop up all at once, so it makes more sense not to have to borrow everything you need at once either.
Example: Eddie the Entrepreneur has $200,000 in equity built up in his home. His lender approves him for 85 percent – the typical approval amount for a HELOC – but he decides he only needs $50,000. He borrows $10,000 at first to buy equipment and get a location.
He’s ready to start paying it back when his first client defaults on an invoice. He borrows another $5,000, knowing that it’s not the end of his credit and that he expects revenue to pick up soon.
HELOC for Small Business Entrepreneurs – Pros & Cons
Of course, we hope that things will work out for our fictional friend Eddie, but there’s no guarantee. Starting a small business is always a risk, no matter how solid your business plan is.
Will it work out for you? It’s impossible to tell. There are a lot of factors involved, from how much equity you’ve accumulated to what your cash flow is likely to be as a new small business owner.
That said, there are some pros and cons that apply to most HELOC borrowers.
The Pros
- More affordable interest rates (approximately 1.38 percent lower than a home equity loan and potentially 5.22 percent lower than a bank loan)
- Freedom to use the financing as you like (which is not necessarily true for a small business loan!)
- The ability to borrow and repay as your cash flow allows
The Cons
- Using your home as collateral. If your business fails, you could lose your home
- High closing costs and fees, including ongoing inactivity fees or early repayment penalties
- Variable interest rates cause your monthly payment amount to skyrocket if market rates rise
Using a HELOC for small business funding tends to be most risky if you’re selling a product, opening a restaurant, or starting up a retail store. These businesses tend to have a lot of up-front costs and can take longer to make their way into the black. Service industries can turn a profit faster, but you’re still stuck with your home on the line if it doesn’t happen fast enough.
Also, many business owners have difficulty even qualifying for a HELOC. Lenders don’t usually let homeowners borrow against their equity without a W2, which you can’t get if you’re a sole proprietor or LLC.
HELOC Alternative for Small Business Owners
Granted, a HELOC is only one of the loan types that you can take out to start your small business. But most of these, from a personal loan to a cash advance, still require W2 forms. The payday loan doesn’t, but it comes with an astronomical APR – approximately 400 percent.
In the past, the only way you could get your home equity without taking out a loan was to sell your home and move out. But who wants to be looking for a new primary residence and packing to move while starting a new business?
There’s a better way.
A sale-leaseback allows you to sell your home but keep living in it. It’s not a loan, so you don’t have to put your home on the line to get your equity. Also, there’s no need to submit a W2 or even a tax return, so it’s significantly more accessible to small business owners.
Key Takeaways
With a sale-leaseback, you can keep paying rent until you’re ready to buy back the property or move. Meanwhile, you can focus on growing your business. Talk to a financial advisor to decide which solution works best for your needs.
