One in five small business owners borrow against their homes to fund their businesses.
Plummeting house prices have hurt small businesses – and will continue to do so, says a new study.
The report – done by the Federal Reserve Bank of Cleveland – fingers falling home prices as a major factor in small businesses' struggle for credit, because many small-business owners use their homes as collateral for business loans or home equity loans to fund business costs.
"Decreased demand for credit, declining creditworthiness of small-business borrowers, an unwillingness of banks to lend money to small businesses, and tightened regulatory standards on bank loans have all been offered as explanations," Mark Schweitzer, the Cleveland Fed's senior vice president and director of research, said in the report. "We believe that other limits on the credit of small-business borrowers are also at play and could be harder to offset. Specifically, the decline in home values has constrained the ability of small business owners to obtain the credit they need to finance their businesses."
Schweitzer and co-author Scott Shane, a professor at the Weatherhead School of Management at Case Western Reserve University, say that nearly 20 percent of small-business owners borrow against their home when taking out a business loan. Slightly fewer use their home's value to back a home equity loan to fund their business.
While home equity loans taken by business owners increased between 2004 and 2007 – when home prices surged – dropping home prices have reduced the availability of home equity loans and thus dropped the amount of business capital available to small-business owners, the Fed said.
A previous study by the Atlanta Fed found that 15 percent of small businesses said lack of equity (home or business) was a hurdle to getting more credit.
The report concluded that the home price issue was a policy-making challenge.
Wrote the authors: "The solution is far more complicated than telling bankers to lend more or reducing the regulatory constraints that may have caused them to cut back on their lending to small companies. Returning small business owners to pre-recession levels of credit access will require an increase in home prices or a weaning of small business owners from the use of home equity as a source of financing. Neither of those alternatives falls into the category of easy and quick solutions'.
Inc. contributing editor COURTNEY RUBIN was for five years a London-based staff writer for People magazine. Rubin, a former senior writer for Washingtonian magazine, has written for the New York Times magazine, Time, Marie Claire, and other publications. She is the author of The Weight-Loss Diaries.