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How a HELOC can help small business owners

HELOCs can be used for nearly purpose, including funding your business, but be aware of the associated risks. Getty Images

According to real estate analytics firm CoreLogic, American homeowners have an average of over $274,000 in home equity in 2023. Many are choosing to tap into that equity for cash through a home equity loan or home equity line of credit (HELOC), with HELOC lending reaching its highest level since 2007 in 2022.

Homeowners can access cash through their homes for various purposes, such as to consolidate high-interest credit cards or fund a major home renovation. You can even use your cash from your home to fund your small business.

However, you must be aware of the risks of pursuing this path. According to the Bureau of Labor Statistics, 20% of small businesses fail within the first year, and 50% fail by the fifth year. You may not want to jeopardize your home on the success of your startup. However, you might feel more comfortable using your home equity if your business is already established with strong long-term projections.

Below, we'll break down what you need to know about how HELOCs work, how to use them for a small business and alternatives to consider. Explore your HELOC options here now to see what you could qualify for.

How a HELOC can help small business owners

To truly understand how a HELOC can help small business owners it helps to first know how this borrowing option actually works.

How do HELOCs work?

HELOCs are a type of revolving line of credit that enables you to borrow against the equity in your home. Like credit cards, HELOCs allow you to borrow whenever you need to, for as much as you need up to your credit limit. You can continue to borrow on the line of credit as you make purchases and pay down your balance. Typically, you pay a variable interest rate only on the amount you borrow.

Most lenders require you to have at least 15% to 20% equity in your home. That's the amount of your home's appraised value minus what you owe on the mortgage. So if your home is worth $400,000 and you owe $320,000, you have $80,000—or 20%—equity. You may be eligible to borrow as much as 85% of your home's equity, depending on your creditworthiness, debt-to-income (DTI) ratio and other factors.

HELOC terms can range from 20 to 30 years and include two periods:

  • Draw period: As its name suggests, you can withdraw funds from the HELOC during the draw period, which typically lasts 10 years. You'll make interest-only payments during this time, but your lender may allow additional principal loan payments.
  • Repayment period: Once the draw period expires, you can no longer make withdrawals and you must repay the balance, including both the principal and interest, or consider refinancing the HELOC. The repayment term typically lasts for 20 years.

Remember, that HELOCs are considered second mortgages, which means they are secured by your home. As such, your lender could foreclose on your home if you fail to pay your monthly HELOC payments.

Learn more about your HELOC options here now.

How to use a HELOC to fund a small business

During the HELOC draw period, you can withdraw money to purchase new equipment, launch a new marketing campaign or pay for other business expenses. Just as you would with a credit card, you can withdraw against your line of credit, pay off the debt balance and borrow again as needed.

Since the HELOC funds are for business purposes, consider opening a business checking account and moving the money there. This step can help you keep your business and personal finances separate and make it easier to track your business expenses.

Because a HELOC is secured by your home, it may be easier to qualify for one than an unsecured loan. HELOCs usually have lower interest rates than credit cards and personal loans and may be lower than some small business loans.

HELOCs come with other advantages for small businesses, such as:

  • Large borrowing amounts: With sufficient home equity, you may be eligible to borrow a substantial sum with a HELOC.
  • Long repayment horizon: Typically, the draw period lasts for 10 years, followed by a repayment term of 15 to 20 years, potentially giving you plenty of time to repay the loan.
  • Inexpensive payments to start: Depending on the amount you borrow, your monthly interest-only payments during the draw period may be manageable for your small business.

Alternatives to fund your small business

If you're not sure whether you should fund your small business with funds from a HELOC, consider the alternatives. These options may come with higher interest rates but don't require you to put your home up as collateral.

  • Small business loan: Small business loans are often affordable options to finance your business. In particular, SBA loans are guaranteed by the U.S. Small Business Administration and tend to offer lower interest rates, fees and down payments and more lenient collateral requirements than other business loans.
  • Business credit card: As you might imagine, business credit cards are similar to personal ones but intended solely for business use. They often come with higher credit limits than your personal credit card, and they can help you establish business credit for future use.
  • Personal loan: Personal loans can help you fund your small business with borrowing amounts ranging from a few thousand dollars up to $100,000. This installment loan typically features fixed interest rates, meaning your payment will remain the same over your loan term, typically between one and five years. While interest rates are usually higher than those from HELOCs, most personal loans are unsecured, so you won't have to put up your house or any other asset as collateral.

Drawbacks of using a HELOC for a small business

While a HELOC may be beneficial in certain business situations, it's wise to consider the downsides of using a HELOC to fund your small business, including the following:

  • Home is collateralized: If your business fails or your income isn't enough to make your HELOC payments, your lender could foreclose on your home.
  • Variable interest rates: Most HELOCs have variable interest rates tied to the prime rate or another index. As a result, your interest charges and monthly HELOC payment could rise and make it challenging to repay.
  • High payments during repayment term: Be aware that your payments may significantly increase during the HELOC's repayment term. Also, note that some lenders may require a balloon payment at the end of the draw period.
  • Potential for increasing debt: As noted above, small businesses have a high failure rate. Using a HELOC to fund your business could leave you with significantly more debt and no way to repay it if your business doesn't succeed.

A HELOC may be worth it to provide financial flexibility for your small business, but it must be managed responsibly. Carefully weigh the benefits and downsides of financing your business with a HELOC before taking the next step. Research your HELOC options here today to learn more.

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