What You Need To Know About Funding Your Startup With A Home Equity Loan
You’ve made up your mind, and you’re ready to ditch the traditional 9-to-5 and forge your own path to success. You are geared up to take the next step by launching a startup. You’ve determined your legal structure, you’ve written out a business plan, and you’re ready to bring your idea to fruition. There’s just one problem: you don’t have the funds to get your business off the ground.
Finding funding for any business can be a challenge, but startups face even more obstacles. This is because most lenders reduce risk by working with more established businesses that have a track record of success. Even if you do find a lender that works with new businesses, you may face excessive fees, high interest rates, and short repayment terms.
To get an affordable loan with terms that work best for your startup you have to get creative. If you own your own home, one of the ways you can fund your startup costs is by applying for a home equity loan.
Of course, like other types of funding, home equity loans come with benefits and drawbacks that you should carefully weigh before submitting your application. In this post, we’re going to explore the pros and cons of using a home equity loan to fund a startup. Read on to find out more.
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What Is A Home Equity Loan?
To understand a home equity loan, you first need to understand equity. Equity is the difference between the value of the home and the amount owed on the home. So, for example, if the value of your home is $500,000 and you have a remaining loan balance of $200,000, the equity you have is $300,000. Equity can grow as you pay down your first mortgage or if the value of your property increases.
You can use this equity as collateral for funding that can be used for any purpose, including launching your business, by receiving a home equity loan. A home equity loan is also known as a second mortgage, and it provides you with a lump sum of cash that you repay in monthly installments over several years.
If you want a more flexible funding option, you may want to consider a home equity line of credit (HELOC). A HELOC allows you to use your home’s equity for a flexible line of credit. With a HELOC, you’ll enter into the draw period, which typically lasts one year. During this time, you may draw from your line of credit up to the limit set by the lender. At the end of the draw period, you enter the repayment period, where borrowed funds are repaid through scheduled installments. Once the funds have been repaid, you may be eligible to begin drawing funds again.
Want to learn more than just the basics? Find out everything you need to know in our post, The Complete Guide To Home Equity Loans For Business Purposes.
How Home Equity Loans Can Be Used To Start A Business
One of the best things about home equity loans and HELOCs is that there are no restrictions on how you use your funds. While many business loans have restrictions on how funds are used and what industries qualify, these same restrictions do not apply to home equity loans and HELOCs. As long as you meet the criteria for borrowing, you can use your funds any way you choose, including funding startup costs.
Some of the ways that you can use your home equity loan include:
- Purchasing or leasing commercial property
- Buying equipment
- Purchasing inventory
- Hiring and training staff
- Marketing campaigns
- Paying taxes
- Business insurance
But the possibilities don’t end there. If you don’t want to start a business from scratch, a home equity loan opens up additional opportunities for entrepreneurship. You can use your loan to acquire an existing business, or you can open up a franchise. The flexibility offered by home equity loans and HELOCs is just one of the many reasons that aspiring entrepreneurs choose this type of funding.
Equity Loans For Starting A Business: Pros & Cons
Before you jump online or head to your local bank to apply for a home equity loan, it’s important to take a look at the overall picture. Sure, home equity loans offer many benefits and could be the right option for funding your startup costs. But these loans also have their own set of drawbacks that you should consider before filling out an application.
- Flexibility: Some lenders offer financial products that come with restrictions. For example, you may not be able to use your funds if you work in a certain industry, or you may be limited to only making specific purchases (i.e., equipment financing that is used to purchase equipment). Home equity loans don’t have these same restrictions, allowing you to spend your funds as needed to launch your business.
- Low Interest Rates: Lenders evaluate risk, and often, small businesses are seen as risky investments. While established businesses with high revenues and solid credit profiles may qualify for affordable loans, new businesses may face high interest rates and excessive fees. With a home equity loan, the equity in your home serves as your collateral, resulting in less risk for the lender and lower interest rates for you. In addition, the interest you pay may potentially be tax-deductible.
- Longer Repayment Terms: If you want a loan that you can pay back over a longer period of time, a home equity loan may be the right choice for you. In general, expect to get between 5 to 15 years to repay your loan.
- Easy Application Process: Applying for a home equity loan may be much easier than receiving a small business loan. Typically, there are fewer paperwork requirements, and the process may be even faster if you work with the lender on your first mortgage.
- Putting Your Assets At Risk: If you pay back your home equity loan as agreed, you won’t lose your property. However, if you default on your loan, your lender can foreclose on your home. If you’re in a particularly risky industry such as retail or food service, make sure you understand exactly what’s at stake before applying for a home equity loan.
- Qualifying May Be Difficult: Although home equity loans allow you to bypass many of the requirements of small business loans (i.e., time in business and annual revenues), you will still need to meet the criteria of the lender. This includes but is not limited to having a solid personal credit profile, meeting the lender’s loan-to-value requirements, and having enough equity in your home.
- Upfront Costs: Some fees are required before you can receive your funds from a home equity loan. Some potential fees include origination fees, underwriting fees, recording fees, and closing costs.
Finding financing options for your startup business can be a challenge, but home equity loans can help you get the money you need at an affordable cost. However, as with any other financial product, it’s important to weigh out the pros and cons and explore all options before signing on the dotted line.
Unsure if a home equity loan is the right choice for you? Check out other startup loan options that may be a better fit for your situation.