When you’re looking for ways to fund your business, you may be tempted to tap into the equity you’ve built in your home.
A home equity line of credit (HELOC) offers flexible access to cash and can be easier to qualify for than other forms of business financing, especially if you’re just starting out.
But there are some serious downsides to using a HELOC for business purposes. For starters, you could lose your home if you default.
We’ll start with a brief questionnaire to better understand the unique needs of your business.
Once we uncover your personalized matches, our team will consult you on the process moving forward.
What is a HELOC?
A HELOC allows you to borrow against your home’s equity, which is the difference between your home’s market value and your mortgage balance. Most lenders allow you to borrow up to 85% of your home’s value, minus your mortgage — though total caps vary by lender.
For example, if your home is worth $500,000 and you owe $200,000, you may be able to access up to $225,000.
A HELOC works sort of like a credit card: once approved, you can borrow as needed up to your limit. As you repay, those funds become available again throughout the “draw period,” which typically lasts 10 years. After that comes the “repayment period,” where borrowing ends and you pay back what you owe (up to 20 years).
Most HELOCs have variable interest rates that often start lower than rates on traditional small-business loans.
To qualify, you’ll generally need a credit score of at least 640, a minimum of 15% home equity and a low debt-to-income ratio.
Can you use a HELOC to start a business?
Yes. Because HELOCs don’t restrict how you use the funds, you can legally use one to cover startup costs. This is one of the workarounds for new entrepreneurs who don’t yet meet all of the requirements for traditional business loans.
But just because you can use a HELOC to bootstrap your business doesn’t mean you should.
When a HELOC for business might make sense
Because your home is on the line, you want to think of using a HELOC as a last-resort option.
That said, there are specific scenarios where tapping into your home equity could make sense, provided you understand the risks and have a solid plan in place:
You’re just starting out
Many traditional small-business loans require two or more years in business and steady revenue. If you’re in the early stages of launching your company, you likely won’t meet that bar. Because a HELOC is based primarily on your personal finances (specifically your home equity and credit score), it doesn’t require any business history.
🤓Nerdy Tip
If you need a lump sum of $50,000 or less in funding, microloans are a good alternative. These small-dollar business loans were designed, in part, to help new entrepreneurs.
You have a clear plan to repay the debt
The best way to use a HELOC for business is to cover short-term cash flow gaps, like a seasonal dip, or high-impact investments, like equipment, software or inventory, that you’re confident will boost revenue. Ideally, you should be able to recoup the money quickly, minimizing both interest costs and the risk of falling behind on payments.
You have a backup plan
Roughly half of small businesses close within their first five years, according to the latest data from the U.S. Bureau of Labor Statistics[0]. That’s why it’s important to have a backup plan to cover HELOC repayments in case your business doesn’t pan out.
Your backup plan might include a working spouse with reliable income, a sizable cash cushion or liquid assets or investments you can tap if needed.
You want flexible monthly payments
A HELOC can offer greater flexibility than many traditional business loans when it comes to paying it back. You may be able to stretch payments over 20 to 30 years, and during the first 10 years, you may only be required to make interest-only payments.
This repayment structure can significantly lower monthly payments on borrowed cash compared with traditional business loans, which often require full repayment within five to 10 years (or sooner). Just keep in mind: The longer you take to repay the balance, the more you’ll pay in total interest over the life of the loan.
You don’t have other large assets to use as collateral
Using collateral is one way to secure a business loan with lower interest rates and better terms. And many business loans require it. But if you’re just starting out or running a lean operation, you likely won’t have much in the way of business assets.
In that case, a HELOC can help secure funding with favorable terms and rates since lenders have the safety net of your home to fall back on in case you don’t make payments.
Pros and cons of using a HELOC for your business
Pros:
Potential option for startups. Approval is based largely on your personal credit and home equity, not your business’s age or revenue.
Generous repayment terms. Many HELOCs offer interest-only payments during a draw period that can last 10 years, followed by a 10- to 20-year repayment period. Payments are also made monthly.
Flexible access to funds. You can borrow only what you need, when you need it, and pay interest on only what you borrow.
Lower interest rates. HELOCs often have lower rates than small-business loans.
Cons:
Risk of foreclosure. Because your home serves as collateral, defaulting on the loan could cost you your house.
Variable rates. Interest rates can rise over time, increasing your monthly payment.
Reduces home equity. Borrowing against your home decreases the equity you’ve built. This can put you at risk of being underwater on your home if its value drops. It can also mean less cash available for a down payment on a new home if you wish to move in the future.
Doesn’t build business credit. Since a HELOC is tied to your personal finances, it won’t strengthen your business credit profile. It can, however, help build (or hurt) your personal credit score.
Alternatives to HELOCs to fund your business
Business line of credit
Like a HELOC, a business line of credit lets you draw cash on an as-needed basis, making it another good choice for covering short-term or surprise expenses. Banks tend to offer the best rates and terms, but you’ll need to have an established business and a credit score of around 700 or higher to qualify. Online lenders may be more startup friendly, but their interest rates are often much higher than those on a HELOC.
SBA microloans
If you have a clear idea of how much funding you need, an SBA microloan can be a strong alternative. Like HELOCs and other microloans, these loans can be used for a wide range of business purposes and are often accessible to startups. They also come with competitive rates and may be available to borrowers with credit scores starting at 620.
Personal business loans
Similar to microloans, personal loans typically provide up to $50,000 in funding. This may be a good option if you can’t qualify for traditional business financing and want a loan with fixed interest rates without putting your home on the line.
Small-business grants
If you don’t need much money and don’t mind doing a little legwork, business grants can provide free money with no strings attached. But they can be very competitive and time-consuming to apply for.
