HELOCs are great for many things. Starting a business is not one


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Owners are sitting on potential opportunities, but not all of them are worth taking.

Home values ​​have increased dramatically in recent years. This means homeowners have significantly more net worth – an average increase of $60,200 over the last year in the second quarter of 2022, according to data from CoreLogic.

Many homeowners have taken advantage of this equity to borrow money using home equity loans or lines of credit (HELOCs) for expensive projects like renovations. But some people may have bigger plans, like using the equity in their property to start a business or fund a startup. And with greater potential equity to borrow from, now may be the time to act.

Owners considering using their capital to start a business should think long and hard before doing so, says Tim McGrathCFP, managing partner at Riverpoint Wealth Management in Chicago.

“Anyone who starts a business thinks they won’t fail,” says McGrath, adding that would-be entrepreneurs would do well to consider the pros, cons and risks before tapping into their capital – and consider alternatives. that will not endanger your home.

Understanding home equity

Before determining if borrowing against your home to finance a business is a good idea, make sure you understand the ins and outs of your home’s equity.

Home equity — the difference between a home’s market value and the balance remaining on a buyer’s mortgage — can be used as collateral for a home equity line of credit (HELOC). Homeowners can use a HELOC much like a credit card because it’s a revolving line of credit. You will only pay interest on what you actually borrow, and the interest rate tends to be variable, moving up and down with the market.

“HELOCs are the easiest way to leverage equity because there are low costs to do so,” says Nicole RuethProducer Branch Manager with the Rueth Powered by OneTrust Home Loans team.

Home equity loans are another way to borrow, but they are lump sum loans. You borrow a certain amount and repay it in installments, usually at a fixed interest rate.

Pro tip

Remember that HELOCs often have variable interest rates, which means your minimum monthly payments may not always be the same. During a period of rising interest rates, this is something to remember before borrowing against your home.

Can a home equity loan or HELOC be used to start a business?

Home equity loans and HELOCs can be used to start and finance a new business, so if you’re a homeowner who has benefited from an increase in the value of your home, this is a potential financing avenue you can explore. And since a HELOC is a revolving line of credit (again, much like a credit card), you can use it when you need it, rather than withdrawing a large sum of money via a loan for value. home.

What can you use a HELOC to pay for? Pretty much anything, as there are few, if any, restrictions. The money could be used to pay for equipment, offices, staff and other costs.

There are many more expenses involved in starting a business, but HELOCs can help you eliminate most of them. But remember: the funds are borrowed from your home – so there’s potentially a lot at stake.

Using a Home Equity Loan or HELOC to Start a Business: Pros and Cons

Home equity loans and HELOCs have their pros and cons when it comes to paying the costs of starting a business.

Advantages

With the increase in home values ​​in recent years, many homeowners have more equity available than ever before. “We all got this gift of equity,” Rueth says, adding that it “opened up opportunities for millions of people.”

HELOCs also tend to have low associated costs and tariffs. “Rates on HELOCs have traditionally been very attractive,” says McGrath. They are also quite easy to access. Getting a big loan (like a mortgage) can be a daunting process, but HELOCs are relatively quick to get because you already own the house.

The inconvenients

With HELOCs, the payments aren’t fixed – they’re based on what you borrow and the interest rate. You will need to know what you can afford to repay each month. “The problem with HELOCs is that you have to manage it within your budget,” says Rueth.

HELOC interest rates are variable – and they increase as the Federal Reserve raises its rate to combat high inflation. This can make your payments more expensive even if you don’t borrow more money, affecting your monthly budget in ways beyond your control.

The biggest downside to borrowing against home equity is the risk: if you don’t make your payments, you could face serious consequences as a homeowner. Worst case scenario? Your accommodation is seized.

Advantages

  • Fairness is here

  • Low costs

  • Easy access

The inconvenients

  • More difficult to budget

  • Change in interest rates

  • Your home is in danger

Experts Take: Is It Wise to Use a Home Equity Loan or HELOC to Start a Business?

With the pros and cons in mind, let’s get down to business: is using a HELOC to open a business a good idea? Experts tend to look for other sources of financing if you are considering starting a business, given the risks involved.

The biggest risk is that you could lose your home. Rueth says to only spend what you can afford and make sure you stick to a payment schedule. “If people are looking to start a business, make sure the amount you get from the HELOC is an amount you can budget to pay back in a managed period of time,” she says.

Prospective business owners should try to find other sources of funding before leveraging their capital. “Look to see if there are other sources of equity or cash,” McGrath says. This could include business loans, personal loans, or even a small business line of credit. “We’ve seen so many clients put money into a business, and the business fails — and it’s not just that the business fails, but their financial future is devastated,” he says.

McGrath recommends against using home equity to fund a business. Ultimately, he says, the risks are just too great for most homeowners.

“I’m not a big fan of it – businesses have a very high failure rate,” he says, “and if you had to take money out of your house to start a business and it failed, you have real problems.”

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