By Jerry Brown
A HELOC lets you tap your home equity to borrow money as you need to, so it could help you grow your business or help sustain it during tough times. Plus, you might be able to get a lower interest rate since the loan is secured by your home. However, using a HELOC for business purposes also comes with risks. Before deciding whether to use this type of loan, learn what those risks are and consider alternative ways to pay for business expenses.
Is it a good idea to use a HELOC for my business?
If you can afford to repay the loan, then using a HELOC for your business could be a good idea. While there are few risks, a HELOC does use your home as collateral, and the line’s variable interest rate means your monthly payments could increase. To help you decide whether it’s right for you, take a look at the benefits and risks of using a HELOC for your business.
The benefits of using a HELOC for business
- Easier to qualify for: Since a HELOC is a secured loan — using your home as collateral — the lender considers the loan less of a risk. Because of this, a HELOC is usually easier to qualify for than an unsecured loan, which doesn’t have an asset attached to it.
- Low interest rates: As of May 5, the average HELOC rate was 4 percent. This is much lower than the average rate for other types of debt. For example, during the same time period, the average credit card rate was 16.07 percent.
- More flexible repayment periods:HELOCs come with draw periods that usually last 10 years. During this period, you can withdraw funds and only repay interest on the amount you borrow. Once the draw period ends, you’ll typically have 15 to 20 years to repay the principal and interest.
- Large amounts may be available: If you have a large amount of equity in your home, you might be able to borrow a large amount of money with a HELOC. Some lenders will let you borrow up to 85 percent of your home’s combined loan-to-value ratio.
The risks of using a HELOC for business
- Variable interest rates: Although you may secure a low rate initially, since the interest rate is variable, it could rise in the future. This would cause your borrowing cost to increase. The unpredictable nature of the interest rate can make it more difficult for you to create a repayment plan. Use a HELOC calculator to estimate how much your monthly loan payments might change if the rate goes up or down.
- Risk of defaulting: If your business fails or you experience financial hardship and find yourself unable to repay the loan, the lender can foreclose on your home. This will also cause your credit score to suffer a major blow, making it harder for you to qualify for future loans.
Alternatives to using a HELOC for your small business
If you don’t think using a HELOC is a good idea for your small business, here are some alternative options to consider.
Home equity loan
A home equity loan is similar to a HELOC in that it is a loan secured by your home. Unlike a HELOC, it usually has a fixed interest rate and the funds are issued as a lump sum. If you choose this option, the fixed monthly payments may be better for your budget. Also, it has lower average interest rates than personal loans and credit cards.
Unlike home equity loans, personal loans are usually unsecured — the lender can’t seize your assets without a court’s permission. When a lender reviews your application, approval depends heavily on factors such as your income, debt-to-income ratio and income. Although the length of loan terms varies based on the lender, the range is usually from one to five years.
As of May 5, the average rate for personal loans was 11.79 percent. However, rates range from 3 percent to 36 percent. The rate you get will depend on your credit score and other factors. Having a high credit score usually means securing a lower rate.
Small-business line of credit
A business line of credit is a loan that works similarly to a credit card and HELOC in that you borrow money on an as-needed basis. With this option, you can borrow only what you need for your business. Business lines of credit can be secured or unsecured, and interest rates vary between the two options.
Small-business credit card
A small-business credit card works like a regular credit card, but you use it for business expenses. If you pay off the card’s balance on or before the due date, you can avoid paying interest altogether. In addition, some small business cards come with interest-free periods that last up to 12 months. As long as you pay the balance off before the promotional period expires, you can avoid interest payments.
Secured or unsecured business loan
Another option you have to fund your business expenses is taking out a secured or unsecured business loan. When you take out a secured business loan, the lender will require you to secure the loan with an asset. Although you can use a business asset — land, equipment or a building — lenders will let you choose what type of collateral to pledge. An unsecured business loan doesn’t require collateral.
To qualify for a small-business loan, your business will have to meet the lender’s minimum requirements. For example, some lenders require that your business has existed for a certain number of years or generate a minimum amount of annual revenue.
The bottom line
When choosing between using a HELOC for business and other funding options, you should compare the interest rate and terms of each option, the loan amount and the consequences for defaulting on the loan. If you use a HELOC for business, you might be able to secure a lower rate and a larger loan amount than with other types of loans.
However, you have to decide if the risk of potentially losing your home is worth it. If you decide it’s not, research other options.