How To Get A Home Equity Line Of Credit (HELOC) For Your Business
It’s not uncommon to encounter challenges on the path to business funding. Opening a new business or suffering from a lack of business credit, for example, are just a few of the hurdles that may prevent you from getting extra capital for your business. If you’re facing this situation, where do you turn? Sure, you could reach out to alternative lenders with few borrower requirements, but high interest rates, short repayment terms, and additional fees could pose a financial burden to your business. Instead of settling for these less-than-favorable options, try getting creative — like using a home equity line of credit for your business.
If you own your home, you may be able to leverage your property to get a home equity line of credit (HELOC). With a HELOC, you’ll be able to tap into your equity to get a flexible line of credit that can be used for any business purpose, from startup expenses to expansion.
Like other financial products, a HELOC isn’t the right choice for every situation. In this post, we’ll take an in-depth look at using a HELOC for your business. We’ll delve into the pros and cons, discuss requirements, and help you determine whether this is the right financial decision for your business. Read on to learn more.
Table of Contents
What Is A Home Equity Line Of Credit?
A HELOC is a line of credit that is issued based on the amount of equity in your home. Essentially, it is a second mortgage that gives you instant access to cash and is repaid over a period of time.
Once you’ve been approved for a HELOC, you’ll be able to borrow up to the limit assigned by your lender during the draw period. Once the draw period is over, you enter the repayment period. During this time, you are unable to draw from your line of credit but will begin paying it back based on the terms set by the lender. Typically, payments are made once per month and are applied toward the principal (the borrowed amount) and the interest that is charged by the lender. Interest rates for HELOCs are usually variable and are based on the prime rate. While repayment terms vary by lender, most HELOCs have terms up to 20 years.
Once you’ve repaid your balance, your line of credit becomes available to use again. Your credit limit is determined by the amount of equity you have in your home, less any current balances on loans. We’ll go more into how lenders calculate your maximum borrowing amount later in this post.
A HELOC is a good financing option for any business in any industry. Startups and brand new businesses that may not qualify for small business funding can score low rates and favorable terms with a HELOC. Businesses that fall short of business credit score, annual revenue, and other small business loan requirements may also benefit from a HELOC.
However, it is important to note that while you may be able to get a large sum of money with a low cost of borrowing, HELOCs aren’t without their risks. If your business goes under and you go into default, for example, you risk losing your home since it serves as the collateral for your line of credit.
Who Is Qualified For A HELOC?
Not every applicant will qualify for a HELOC. There are certain requirements that you must meet in order to be approved for a line of credit.
The most obvious borrower requirement is that you must own your home. Your home serves as the collateral for the HELOC, so if you don’t own your own home, seek other forms of funding.
In addition to owning your own home, you must also have enough equity built up to qualify for a HELOC. The amount of equity you need varies by lender, but most require that you have at least 15% to 20% equity. Equity is built up by paying down your original home loan or if your property value increases significantly.
Having equity in your home isn’t enough to qualify for a HELOC alone. You must also have a solid credit profile. At a minimum, a fair personal credit score is required to receive a HELOC. Like other financial products, borrowers with the best credit scores will receive the lowest rates and best terms. Borrowers with fair scores or lower may face higher interest rates, need a lower debt-to-income ratio, or have more equity in their homes than borrowers with good to excellent credit scores.
Speaking of debt-to-income, this is another factor lenders use for approval. Lenders are all about risk, and they want to work with borrowers that are able to afford their loans. An applicant with a high DTI has many obligations and is seen as a riskier borrower. We’ll discuss calculating your DTI and how to lower it in the next section of this post.
Finally, you should be prepared for the upfront costs associated with a HELOC. Costs may include but are not limited to attorney’s fees, application fees, and appraisals.
How To Get A HELOC For Business Purposes
If you own a home with equity and a HELOC sounds like a good way to fund your business, read on to learn more about the next steps you need to take to get your line of credit.
Calculate & Lower Your Debt-To-Income Ratio
As previously mentioned, one of the things that lenders look for when approving HELOC applications is a low debt-to-income ratio. Before you start the application process, you can calculate your DTI yourself. If it’s too high, there are some steps you can take to lower it.
To calculate your DTI, divide your monthly outstanding debt (including your first mortgage) by your monthly gross income. This number is expressed as a percentage. For example, let’s say that your gross monthly income is $3,800. Your total monthly debt is $1,500. Use the following calculation to figure out your DTI:
Monthly Debt / Monthly Gross Income = DTI
$1,500 / $3,800 = 0.39 or 39%
In most cases, lenders look for a DTI of 50% or lower.
If your DTI is on the higher side, there are two ways that you can lower it to qualify for a HELOC. The first is to reduce your debts. Pay down balances or pay off other obligations if possible to lower your amount of debt and, with it, your DTI.
The other way to lower your DTI is to bring in more income. Even if your debts remain the same, a higher income can help bring down your DTI to where it needs to be to score a lender’s approval.
Understand LTV & Your Maximum Borrowing Amount
Lenders look at the amount of equity you have in your home to not only qualify you for a HELOC but to determine your maximum credit limit. This is done by performing a few calculations. The first is calculating your loan-to-value ratio, or LTV. Your LTV is calculated by dividing the outstanding balance on your first mortgage by the appraised value of your home.
Let’s look at an example. Your home is valued at $250,000. You have repaid $100,000 on your first mortgage, leaving a remaining balance of $150,000. Lenders will use this equation to find your LTV:
Remaining Loan Balance / Home Value = LTV
$150,000 / $250,000 = 0.6 or 60%
Though it varies across lenders, most want to see an LTV of 80% or less when issuing HELOCs. In this example, you would qualify for a HELOC, assuming you met all other requirements.
Now, to determine your credit limit, lenders calculate your combined loan-to-value ratio, or CLTV. Most lenders allow a CLTV of up to 85%, while some may go as high as 90%, but this varies based on the lender you select.
Let’s look again at the same example. The lender you’ve selected allows a CLTV of 85%. Use this equation:
Home Value x Maximum LTV= Combined Loan-To-Value
$250,000 x .85 = $212,500
You’re not done there. Remember, you still have your first loan to consider. So, to figure out the maximum borrowing amount, subtract your current mortgage balance from the CLTV.
Combined LTV – Remaining Balance = Maximum Borrowing Amount
$212,500 – $150,000 = $62,500.
As you can see, the maximum borrowing amount for your HELOC in this example is $62,500. Of course, this is just an example, and your numbers will vary based on the remaining balance of your mortgage, the value of your home, and the policies of your lender.
Check Your Credit Score & History
Your personal credit score is a very important factor in qualifying for a HELOC, so you should know where you stand before you fill out your first application. The credit score requirements vary by lender, but most lenders require a minimum credit score of 620 to qualify. Other lenders may have higher limits.
In some cases, a lender may approve a HELOC with a score lower than 620. However, the borrower must show a very low DTI and a high amount of equity.
Borrowers with higher credit scores will also receive more favorable terms and lower interest rates than borrowers with lower credit scores.
In addition to having at least a fair credit score, you should also have an overall solid credit profile. You may be disqualified by having any of the following on your credit report:
- Negative Public Records
- Charge Offs
- Mortgage Delinquencies
Requirements vary by lender, so make sure to check out the website, call the lender on the phone, or visit in person to learn more about specific credit requirements.
Applying for a HELOC can be time-consuming, but don’t neglect to take the time to do your research and talk to different lenders. Your goal is to not just find the money you need for your business but to find the most affordable option with the best terms.
Start with the lenders that you have a current relationship with, as these lenders may offer discounts on rates for existing customers. This includes the servicer of your first mortgage, as well as any other institutions where you hold accounts.
However, don’t stop there. Instead, consider all of your options. Smaller community banks, credit unions, and even online lenders may offer the best rates and terms.
Complete Your Application
Once you’ve settled on a lender, the next and final step is to complete your application. Many lenders have simplified this process by offering online applications. Most applications are fairly straightforward, requiring the following information, at a minimum:
- Name & Contact Information
- Social Security Number
- Current Debts & Obligations
- Property Value Estimate
- Borrowing Amount
Supporting documentation will also need to be submitted with your application or at some point during the underwriting process. This may include proof of income and homeowner’s insurance information. Requirements vary by lender.
Once your application and documentation have been submitted, your lender makes a borrowing decision. This process takes some time, so be patient. If approved, you’ll receive your funds after signing your loan contract. If your application is rejected, your lender will provide a reason as to why you weren’t approved.
Frequently Asked Questions
How long does it take to get approved for a HELOC?
Getting a HELOC isn’t an overnight process. The time it takes from application to funding varies by lender. However, you may be able to receive your funds in as little as 30 to 45 days after submitting your application. To avoid potential delays, submit required documentation in a timely manner, and make yourself available to your chosen lender.
Can I get a HELOC if I have a low credit score?
To qualify for the best rates and terms, you should have a high credit score in the 700s. Some lenders may work with borrowers with fair credit scores in the low 600s. However, be aware that you may be required to have more equity or a lower DTI if you have a lower score.
How easy is it to get a HELOC for business purposes?
Getting a HELOC for business purposes isn’t too difficult provided you meet all of the lender’s requirements. There are often fewer documentation requirements than other financial products, particularly if you work with the lender that services your original mortgage. Making yourself available throughout the process to provide additional documentation or to answer the lender’s questions simplifies the process.
A HELOC for business purposes is a great way to get the capital you need to start or expand your business. If you have a solid credit history and a property with equity, you’ll find that the application and approval process is fairly straightforward and easy, giving you access to the funds you need in as little as 30 days.