All businesses need a line of credit. Cash flow is king and unless you have positive cash flow running through the business, it won’t be long before you run out of money to pay creditors, employees, and required corporate taxes. Banks are the most obvious place to turn to when you need business lending or financing, but if your business overdraft is maxed out or you need a larger chunk of money to buy equipment, you need to look at other alternative lending options. One such option is home equity finance or a HELOC (home equity line of credit).
What is Equity?
Equity is the money you have tied up in your home. Most people buy their homes with FHA loans in NJ or elsewhere, but within a few years, it is common to have accumulated a reasonable amount of equity because property prices rise and with each repayment you make, your mortgage balance falls (or that is the case if you have a repayment mortgage). For example, if you have an outstanding FHA mortgage of $100k, but the market is buoyant and your property has risen in value to the tune of $250k, you now have $150k equity to play with. You can’t access this money unless you sell the property and repay the mortgage, but you can borrow against it.
How Home Equity Finance Works
For business owners, home equity financing is very useful, but you have to understand how it works. There are two types of home equity financing.
- A home equity loan lets you borrow against the equity in your property. For example, if you have $100k of equity, you can take out a loan secured on the property. This money can be used to raise money for business expansion, purchase new equipment, or even repay creditors. You make regular capital and interest repayments and in time, the loan is repaid.
- A HELOC is a line of credit tied to the equity in your home. It works like a business credit card, except that you borrow money against your home. You can borrow as much or as little as you like, as long as the amount you borrow doesn’t exceed the level of equity. The good thing about a HELOC is that you only pay interest on the money you use, but interest rates on HELOCs are typically variable. Whilst interest rates are low, your loan repayments will remain low, but if interest rates creep up, your repayments will also increase.
The Pros and Cons of Home Equity Finance
Home equity loans and HELOCs are flexible. There are no restrictions on how you use the cash. It is much easier to secure a home equity loan or a HELOC because the lender is using your home as security. Lenders like to know they can recover the debt if you fail to meet the repayment schedule, so any kind of secured lending is more attractive to a lender, which is why interest rates are lower.
The biggest downside of funding a business using a home equity loan or a HELOC is that the money you borrow is secured on your house. If you default on the repayments, you risk losing your home. You need to give this some serious thought. Your business capital might be doing OK right now, but what would happen if work dries up and you can’t meet your loan repayments? Your family might not appreciate being homeless if the lender decides to foreclose on the loan.
Terminating a HELOC Agreement
As with a mortgage, if you subsequently decide to move house, you will need to settle the loan or HELOC, which could trigger early redemption penalties from the lender. Again, these can be quite expensive, so read the terms and conditions of the loan before you sign on the dotted line.
Home equity loans and HELOCs are a cheap way of funding a business, but you need to be aware of the pros and cons. If you borrow money using either of these methods and fail to make repayments, it will affect your credit rating and you could lose your home. If there is any chance of this happening, look at alternative means of borrowing money to fund the business.
There are always other options available, including selling a share of the business to an outside investor or using a crowdsourcing website to ask for financial assistance to help you grow the business. Look at your options before you make a final decision.
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