You can use the equity you have accumulated in your home to invest in your business. There are multiple ways to do this, including home equity loans, a home equity line of credit, cash-out refinancing, and a home equity investment, also known as a shared equity agreement. However, before investing, you should carefully consider your options and weigh the risks to your home.
Starting a business takes hard work and a sizeable investment, and it can be difficult to obtain the capital needed to start. Even after the business is up and running, a drop in demand for your product or an increase in your expenses can put your business in jeopardy. To be successful takes more than a good idea, a good product, and hard work: it also takes a good cash flow.
It’s estimated that poor cash flow accounts for 84% of all business failures in the United States. So to obtain starting capital or fill the gaps in cash flow, many small business owners draw equity from their homes. While there are advantages to using home equity for business loans, this practice carries risks that you wouldn’t face with a normal small business loan or an investor putting money in your business.
Knowing your options will help you weigh the risks and choose the best option for getting equity out of your home for your business. Let’s take a look at what home equity is and the different ways you can use it to invest in your business.
What is home equity?
Home equity is the difference between what you owe on your mortgage and how much the property is worth. As you pay down your mortgage, you build up your home’s equity.
For example, imagine your house is worth $750,000, and you took out a $500,000 mortgage to purchase it. So far, you’ve repaid $200,000 of that mortgage. That means you have $450,000 of equity in the property that you can leverage for financing.
Here are five ways you can take advantage of your home’s equity to invest in your business: selling your house, home equity loans, home equity lines of credit, cash-out refinances, and home equity investments.
Sell your house
The simplest way to get equity out of your home is to sell your house. You’ll get the full value of your property all at once, which could be a good option for you if you don’t have a mortgage or if your mortgage is much lower than the current value of your home.
Of course, this method also comes with complications. You still need to live somewhere, after all, and you could easily end up spending most of the money from the sale of your old home on a mortgage for a new one. There’s also no guarantee the sale will close before you need the money.
Most importantly, selling your home means you can’t take advantage of the future increased value of your house. Therefore, a better solution may be to get equity from your home without selling it using the other alternatives outlined below.
Home equity loan
A home equity loan is often referred to as a second mortgage. A home equity loan allows you to borrow a fixed amount, secured by the equity in your home, and receive your money as a lump sum. It is repaid monthly, like a regular mortgage, and it can be worth as much as 80%–85% of your home’s equity.
Home equity line of credit (HELOC)
A home equity line of credit, or HELOC, works similar to a credit card. Once approved for a HELOC, you can draw from it as a line of credit anytime during the draw period. A HELOC has a variable interest rate, which is usually based on the prime rate of the day when you draw from the line of credit.
During the draw period of a HELOC, you will only pay interest on what you’ve drawn. Once the draw period ends, the repayment period begins: you will have to repay the balance, and you will no longer be able to borrow money from the line of credit. The terms of the HELOC may require that the remaining debt be paid off immediately or over time. The lender may also reduce the amount of credit available to you during the draw period if the value of your home lowers significantly.
Cash-out refinancing involves taking out a new mortgage for more than you still owe on your initial home loan. You pay off the first mortgage and pocket the difference. A cash-out refinance comes with a variety of fees and closing costs, so make sure to read the fine print before signing on the dotted line. Shopping around with different vendors to find a cash-out refinance option that works for you and your business.
Home equity investment
In a home equity investment, you are selling a share of your property to an investor. The investor then gives you cash for that share that you can use as you wish, with no monthly payments or interest rates attached.
At the end of the agreement, you must pay the investor the amount they initially loaned to you, plus their share of the increased value of your home. For example, if the investment was made in exchange for 50% of the property’s appreciation, and the property then increased in value by by $50,000, you would owe the investor $25,000 in addition to the initial investment. This also means that if your home value drops, you may not owe as much.
Home equity investments may be a good option if you want to avoid monthly payments or if you cannot obtain another type of home equity loan.
Why should I use my home’s equity to invest in my business?
Business loans often come with restrictions, and the smaller a business, the harder it can be to get approved for a business loan.
On the other hand, cash from a home equity loan can be used however you want. You may find it’s much easier to get money for your business by leveraging the equity in your home, either through a lender or from an investor via a home equity investment.
Most lenders also see collateral in the form of property as less risky compared to an unsecured small business loan. You won’t need to show your business plans to prove your business’s viability: if you fail to repay the loan, the lender will simply seize your property.
Pros and cons of using home equity for your business
Here is a list of the benefits and the drawbacks to consider.
- More options: With multiple financing options available, you can choose one that best fits your needs.
- Fewer restrictions: While small business loans come with restrictions, you can use a home equity loan however you want.
- Easier to obtain: Lenders are more likely to approve you for a loan when you use your property as collateral.
- More flexible repayment periods: Mortgages and HELOCs are typically repaid over 15–20 years.
- Risk of defaulting: Using your home as collateral adds to the risk of opening a small business. If you cannot make the payments, the lender can foreclose on your home.
- Variable interest rates: If your loan has a variable interest rate, you could end up paying more.
- Longer mortgage: Refinancing will increase the time it takes to pay off your mortgage.
- Additional costs: Home equity loans often include upfront and closing costs.
How to get equity from your home
Here are some tips for getting equity out of your home to invest in your business:
How to get home equity for your business
- Check your eligibility: Know your home’s equity and compare it to the amount of the loan you need. Don’t expect the full value; lenders will usually require that you retain 15%–20% of your home’s equity.
- Decide if the risk is worth it: Using your home as collateral for a loan means you risk losing it. If you are unable to repay the loan, the lender can seize the property. An unsecured loan won’t put your home at such direct risk.
- Choose the type of loan: If you need a lump sum, consider a home equity loan. If you need cash flow, a home equity line of credit may be best. If you cannot secure a loan, you may want to obtain a home equity investment.
- Shop around: Don’t jump on the first offer you find. Interest rates vary per lender, and there are closing costs, upfront costs, and other fees to compare. If you are refinancing, you do not have to get a loan from the same lender who issued your original mortgage.
Can I use my home equity to buy a business?
Yes. A home equity loan is secured, and you can use the money however you wish, including to buy a business.
How do you get equity out of your house?
There are several ways to get equity out of your home, including selling your house, obtaining a home equity loan, cash-out refinancing, opening a home equity line of credit, or entering a home equity investment.
Can I refinance my home to start a business?
Yes. You can use the money from a second mortgage or a cash-out refinance to start a business.
Can you use home equity for an SBA loan?
Yes, though it is not required for a home equity business loan up to $25,000. If the business’s fixed assets cannot fully secure a loan above $25,000, a home can be used as collateral.
- You can use the equity in your home for your business however you choose, whether for startup costs or for cash flow.
- Using your home’s equity for a business loan means you risk losing your house. If you cannot repay the loan, the lender can foreclose on the property.
- There are multiple ways to leverage the equity in your home, including a home equity loan, a home equity line of credit, cash-out refinancing, and a home equity investment.
- How you plan to use your home’s equity can help you decide which type of loan is right for you.
By now, you probably have a good idea of how you want to use your home’s equity for your business, whether to cover startup costs, fill the gaps in your cash flow, or invest in new equipment or products. Now you need to find the right lender.
SuperMoney has all the reviews and comparison tools you need to find a loan that’s right for you. Compare company reviews, loan amounts, interest rates, and maximum loan-to-value ratios to find the best home equity loans, HELOCs, and home equity investments for all your business needs.
View Article Sources
- My lender offered me a Home Equity Line of Credit (HELOC). What is a HELOC? – Consumer Financial Protection Bureau
- What is the difference between a Home Equity Loan and a Home Equity Line of Credit? – Consumer Financial Protection Bureau
- The Pros and Cons of Using Home Equity to Fund Your Small Business – SCORE
- Small Business Budgeting and Borrowing – University of Nebraska Omaha
- Types of 7(a) loans – U.S. Small Business Administration
Jesse Hughes is a personal finance writer who loves to research complex and poorly understood topics and explain them in plain English. Jess has a background in technical writing and over a decade of experience working with mechanical engineers, so he understands the value of clear and precise writing when covering complex topics.