Entrepreneurs funding new businesses often take loans against their assets — including their homes — in order to pay for business expenses. Using home equity to bootstrap a business has both pros (low interest rates) and cons (risking your residence, should the business fail). Roughly 7% of American entrepreneurs tap their home equity to help finance their startups, according to the U.S. Census Bureau’s most recent Annual Survey of Entrepreneurs. Barlow Research, a firm in Minneapolis, Minn. that tracks small-business borrowing, estimates that as many as 25% of entrepreneurs use home equity loans or use their home as collateral to secure business loans.
If you’re an entrepreneur considering tapping home equity, read on for information about whether this option is right for you, and how to go about it.
Home equity loans come in a few flavors. But before you can apply for one, it helps to understand how home equity works. Here’s a simple formula:
Your home’s current value – the amount owed on the mortgage = home equity
If your home is worth $400,000 and you owe $300,000 on your mortgage, you have $100,000 worth of equity (or 25% equity) in your home. Home values can fluctuate, depending on local market dynamics and time of year, but you can ask a real estate agent for an estimate or use online tools to get a sense of your home’s value. If you apply for a home equity loan, your lender will arrange an appraisal to confirm value.
Generally speaking, lenders who offer home equity loans like to see that you have at least 20% equity in your home before applying for a home equity loan. Unlike a credit card or bank loan, a home equity loan is secured against your residence. This means that if you fail to repay the loan or you enter delinquency, the lender can place a lien on your property or pursue foreclosure in an effort to recoup the debt. Lenders generally don’t want to see you borrow more than 85% of your home’s value. This means that if you have 25% equity, as in the formula example above, you could borrow no more than 10% equity — or about $40,000 in the example — as that would bring your total equity down to 15%.
A home equity loan may be offered as a second mortgage: With this type of loan, you are given funds in a lump sum that you repay at an established interest rate over time. Or, you may tap home equity through a home equity line of credit (HELOC). With a HELOC, the lender sets up a line of credit based on your home equity, and you can tap that credit fully or partially when you wish, provided you make monthly minimum payments on any balance you carry (as with a credit card) over time; some HELOCs may be extended at the end of their terms. HELOC interest rates may be fixed or variable. Unlike a second mortgage, which provides a single cash infusion, HELOCS allow you to “run up” and “pay down” a balance as needed during the life of the loan.
There are several benefits to tapping home equity to fund a startup:
There are downsides to using home equity to fund a startup, too:
Entrepreneurs can pursue multiple avenues to secure funding, from taking friends and family investors to personal loans, regional economic development grants or incentives, borrowing from retirement savings and more.
Running a startup business is demanding but rewarding. Entrepreneurs must choose which available financing resources make the most sense at different intersections in their business’s life cycle — and their own. Home equity is a viable option for many business operators, but not the only resource for supporting the needs of a growing company.
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Source: https://www.magnifymoney.com/blog/mortgage/use-home-equity-loan-fund-startup/