There are many expenses to consider when starting or growing your business, from leasing property and purchasing equipment to hiring and training staff. For many business owners, leveraging home equity for business funding is an attractive alternative, whether through an SBA loan, a home equity business loan, a home equity line of credit (HELOC), or a home equity investment -- a relatively new option available in many states that, unlike other alternatives, does not require taking additional debt.
Each alternative has pros and cons, and business owners will want to think carefully about their individual life circumstances, willingness to take on new debt, and financial flexibility before deciding which path is right for them.
SBA (Small Business Administration) Loan
Maximum funding: $5,000,000
A conventional small-business loan, or SBA loan, is often the first avenue for many business owners seeking funding. Backed by the Small Business Administration, these loans are provided by banks, microlenders, and commercial lenders, and often feature lower interest rates and more flexibility than traditional bank loans.
One major challenge of traditional small-business loans is the red tape and paperwork they require. Many ask for a personal asset guarantee to secure the loan. It's also important to note that if your business is especially small -- say, if you're the sole proprietor or have only two or three employees -- it might be especially difficult to secure a loan. Only about 15 percent of sole proprietorships have business loans.
If your SBA loan application got rejected, you can learn why and get a better understanding of the next steps you can take.
Home Equity Loan for Business
Maximum funding: Typically up to 80-85 percent of your home's value
A home equity loan lets you borrow against the equity you've built in your home, using the home to guarantee the loan. On the plus side, these loans offer predictable interest rates, so your monthly payment remains the same every month, which can be especially appealing if you're looking to use a home equity loan for business purposes.
And unlike most business lines of credit, you aren't required to pay the balance down to zero each year. In fact, a home equity loan can be appealing for its generally flexible repayment periods, which typically range from five to 15 years. In addition, it's possible that the interest on your home equity loan will be tax-deductible.
However, a home equity loan is a second mortgage on your home, so you'll need to be prepared to make an additional payment on top of your existing mortgage. The application and approval process can also be a bit challenging due to lenders' specific requirements.
Home Equity Investment
Maximum funding: Dependent on the investor, but typically up to $500,000
A home equity investment provides cash in exchange for a share in the future value of your home. Unlike a loan or HELOC, you don't have the hassle of monthly payments or interest. You can use the cash for anything you'd like, whether it's purchasing equipment, making office renovations, or expanding operations. The timeline is also relatively quick, and once you're approved, you can receive funds in as little as three weeks. At or before the end of the effective period, which usually ranges between 10 and 30 years, you'll need to settle the investment. You can do that through a refinance, a buyout, or the sale of your home.
As with all home equity products, a homeowner is accessing the value of the home to foster their business' success. But what makes a home equity investment a bit different from the other options outlined above is the potential downside protection it offers. With some investors, If the home value depreciates over time, the amount that investors receive also goes down. Conversely, if a home sees rapid appreciation, the investor sees it too, though the investor's upside is often capped at a percentage of the investment per year.
The home equity investment alternative has been expanding to an increasing number of states.
Maximum Funding: Typically up to 80 percent of your home's value
A cash-out refinance gives you access to cash by paying off your existing mortgage with another one that has a balance of more than you owe on your home. While you can potentially lock in a lower interest rate this way, a refinance extends your mortgage payoff timeline. You'll also be saddled with the fees that came with your first mortgage, including application and closing fees. There are also prepayment penalties and cancellation fees to be aware of.
Home Equity Line of Credit (HELOC) for Business
Maximum funding: Typically up to 80-90 percent of your home's value
If you're looking for flexibility, a HELOC for your small business can be a good option, as it gives you the opportunity to access funds any time and you can take out more as needed without any penalties. The application and approval process tends to be easier than other options. As with a home equity loan, there's the possibility that the interest will be tax-deductible, and the repayment period typically spans from 15 to 20 years.
Yet unlike a home equity loan which usually has a fixed rate, the variable interest rate of a HELOC means that payments will be unpredictable every month. In addition, if your credit score or home value decreases, the lender can freeze your HELOC at any time.