A business equity line of credit is a flexible credit line that offers access to cash, using the equity you’ve built up in your home as collateral. Obtaining a home equity line of credit (HELOC) may be something to consider if you’re unable to qualify for other types of small business financing due to your credit history, the age of your business, or other factors. Using a home equity loan for business has its risks, so it’s important to understand how this type of credit works before you commit.
Table of Contents
- Key Points
- • A small business equity line of credit allows you to leverage the equity in your home to borrow cash for your business.
- • A business HELOC is different from a commercial equity line of credit, which uses commercial property as collateral for the loan.
- • Using a HELOC for business can give you access to cash to fund startup expenses or ongoing operations costs, but if you default, you risk losing your home.
- • Before tapping your home equity, consider alternatives to business equity lines of credit.
What Is a Business Equity Line of Credit?
A business equity line of credit is a HELOC, with a twist. What is a HELOC and how does it work? A HELOC is a revolving line of credit that works similar to a credit card, with one key difference: HELOCs are secured by your home. When you get a business HELOC, you’re accessing the equity in your home through a flexible credit line. Equity is the home’s estimated market value minus whatever you still owe on your home loan.
What can you use a HELOC for? Here are some of the options:
• Funding startup costs
• Purchasing equipment or inventory
• Filling payroll gaps or day-to-day operating expenses
• Covering costs during temporary cash flow shortfalls caused by seasonal sales fluctuations
Business equity lines of credit allow flexibility, similar to a credit card, but it’s possible to qualify for a more favorable interest rate since your home secures the credit line. Collateral shows lenders you have some skin in the game, which helps offset some of the risk associated with the loan.
A business home equity loan can do the same thing. The main difference between a HELOC vs. home equity loan is how the funds are delivered and accessed. With a home equity loan for business, you get all of the money in one lump sum. You make principal and interest payments from day one, until the loan is paid off.
Business HELOC vs. Commercial Equity Line of Credit
A business HELOC is sometimes confused with a commercial equity line of credit. While they largely work the same way, they differ in the type of collateral that’s used. A small business home equity line of credit is backed up by your home; a commercial equity line of credit is secured by commercial property.
For example, say your business owns a couple of warehouses that you use to store inventory or house goods before they’re shipped out to customers. You might use one or both of those properties as collateral for a commercial equity line of credit. This option may be more attractive if you’d rather not put your home on the line to get a loan for the business.
How Does a Business Equity Line of Credit Work?
Business equity lines of credit work like traditional HELOCs, in terms of how you can access funds. A business HELOC has a set draw period, in which you can pull cash from your credit line. During this period, you may only be required to make interest payments based on the amount you’ve borrowed. You could also make payments toward the principal; any payments you make free up more available credit to use again.
Once the draw period ends, the repayment period begins. You’ll repay the amount you borrowed, along with interest, over a set term. For example, you may have a five or 10-year draw period, followed by a 10- to 20-year repayment period. Your monthly payment is higher in the repayment period, so it’s important to consider how that will affect your budget. Once you hit the repayment phase, you won’t be able to make any additional withdrawals from your credit line.
Pros and Cons of a Business Equity Line of Credit
Using a HELOC to build wealth by investing in your business has advantages, but there are risks to consider too. Evaluating the pros and cons side by side can help you better understand what you’re taking on when getting a business HELOC.
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Pros:
• Lower rates A business HELOC may offer a lower interest rate than a personal loan or other types of business loans.
• Cost Small business equity lines of credit charge interest only on what you borrow.
• Flexibility With a HELOC for business, you can withdraw cash as needed for any purpose, pay it down and withdraw again.
• Easier qualification You may find it easier to get a business HELOC vs. other business loans if you’re launching a new company with zero revenue to report.
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Cons:
• Variable rates HELOCs often have variable rates, which means your rate (and payment) can go up or down over time.
• Fees A business equity line of credit can charge closing costs and other fees that add to the cost.
• Risk Your home secures a business HELOC. If you fail to make the payments, the lender could take the home through foreclosure.
• Slower approval The underwriting process for a business home equity line could take longer than other types of business loans or personal loans. An appraisal is usually required.
How to Qualify for a Business Equity Line of Credit
Getting a small business equity line of credit or other HELOC for business isn’t that different from getting a HELOC for any other purpose, such as home improvements, medical bills, or debt consolidation. Lenders will consider several factors for approval, including:
• Credit scores Lenders use your personal credit history to gauge risk. There’s no universal minimum credit score to get a business HELOC. Some lenders may accept borrowers with a score in the 640 range, but the best interest rates typically go to those with the strongest scores.
• Debt-to-income (DTI) ratio Your DTI ratio tells lenders how much of your gross pay goes to debt repayment each month. The lower this number is, the better your approval odds.
• Home equity You’ll need to have an equity stake in the home to borrow against. Most lenders expect you to have 15% to 20% equity, though some may accept 10% equity instead.
Lenders also consider the home’s appraised value, the type of property, and your overall income stability. If you’re starting a brand-new business that isn’t generating any profits yet, you’ll need to have a backup source of income to support your business HELOC application.
The amount you can borrow is determined by all of the above factors. Lenders may have a maximum loan-to-value (LTV) or combined loan-to-value (CLTV) ratio that caps loan amounts. Your LTV measures the ratio between your home’s value and your current mortgage. Your CLTV measures the ratio between your home’s value and all loans attached to the home, including a HELOC. Generally, lenders look for an LTV below 80%, with a maximum CLTV between 80% and 85%.
Alternatives to a Business Equity Line of Credit
Using a home equity loan for business is just one way to meet your needs when starting a new venture, or covering expenses for an existing one. There are several other possibilities you might explore for meeting your small business’s needs.
• SBA loans Small Business Administration loans are guaranteed by the federal government and allow you to borrow without using your home as collateral. These loans do, however, have strict qualification requirements so they may be harder to get for certain borrowers.
• Small business loans A small business loan is specifically designed for a newer business. You may still need 1-2 years of operating history, along with a minimum annual revenue, and good credit. But it may be easier to qualify for this than for an SBA loan.
• Business credit cards A business credit card offers a flexible way to spend, without requiring collateral. You can build business credit, and some business credit cards offer generous rewards. Be aware that you may need to sign a personal guarantee, which means you accept personal liability for any charges you make.
• Personal loans Personal loans let you borrow a lump sum of cash for any purpose and pay it back over time with interest. Personal loan rates may be higher than business HELOC rates, but you don’t need to offer your home up as collateral to get one.
Is a Business Equity Line of Credit Right for You?
Whether you should use a HELOC for business can depend on several factors, including how much cash you need, your business age and revenue, your credit profile, and how comfortable you are using your home as collateral for a loan.
A business HELOC could be right for you if you:
• Have good to excellent credit that could help you qualify for a low rate.
• Have enough equity in the home to borrow against, based on a lender’s minimum LTV and CLTV requirements.
• Can comfortable cover HELOC payments, in addition to your original mortgage payments.
• Are unsure how much cash you need and want a flexible way to borrow.
You might consider alternatives to HELOCs for business if you:
• Own a newer business that isn’t generating revenue yet, or an established business with unpredictable cash flow.
• Have limited equity in your home from which to withdraw cash.
• Are not comfortable with the possibility that you could lose your home if you default on a business HELOC.
If you decide to move forward with a HELOC for business needs, shop around. Compare HELOC options from different lenders to see how the interest rates, fees, and repayment terms measure up. Obtain rate quotes from lenders that allow you to check rates without affecting your credit score. Also, review each lender’s credit score, income, debt, and equity requirements to assess which one you may have the best chances of being approved by.
The Takeaway
A business home equity line of credit can help you tackle short-term financial needs or fund long-term goals. Whether it makes sense to pursue a business HELOC versus another source of financing can depend on how confident you are in the business’s success and your ability to repay a line of credit should the business underperform.
SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $350,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.
Unlock your home’s value with a home equity line of credit from SoFi.
FAQ
Can you use a personal HELOC for business expenses?
You could use a personal HELOC for business expenses, unless your lender expressly prohibits you from doing so. HELOCs are designed to meet a variety of financial needs. If you’re unsure what a lender allows, you can ask about permitted uses for a HELOC before you apply. Remember, though, that if you become unable to make your HELOC payments because your business is unprofitable, you risk losing your home.
Is the interest on a HELOC for business tax deductible?
HELOC interest is typically only deductible when funds are used to build, buy, or substantially improve the home that secures the loan. However, you may be able to deduct the interest on a business HELOC as a business expense. Talk to a tax advisor about when the interest on a business equity line of credit is (or is not) tax-deductible.
What credit score do you need for a business equity line of credit?
The credit score you need to get a home equity line for business depends entirely on the lender. Some lenders may offer loans to borrowers with scores around 640. The higher your score, the better your odds of being approved at a lower interest rate.
What is the difference between a business equity line of credit and a business line of credit?
A business equity line of credit is a credit line that’s secured by your personal residence. A business line of credit is a revolving credit line that is typically unsecured, meaning there’s no collateral required. Both types of credit lines allow you to withdraw cash, pay it back, then withdraw funds again as needed to cover business expenses.
Can a startup get a business equity line of credit?
A startup could get a business equity line of credit, since the age of your business may not factor into a lender’s decision. Instead, lenders are primarily concerned with your credit score, income, how much debt you have, and the amount of equity you’ve built up in your home.
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