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About 15 years ago, Barry Levine was offered a $200,000 loan to use however he pleased. All he had to do was to bet his house that he’d be able to pay it back.
The La Jolla, Calif.-based entrepreneur and his wife planned to use the funds from the home equity line of credit (HELOC), a loan that is backed by the equity of a home, to grow his 30-year-old temperature reading camera-making business, Sperry West. He hired a professional marketing manager, a VP of sales and three salespeople.
“We executed the plan — 100 percent of the home equity money went into the business,” he says. “We didn’t spend any of it on ourselves.”
But things didn’t turn out the way they planned after his new hires didn’t meet the company’s goals.
The Levines could no longer afford to pay their massive $12,000 to $13,000 monthly mortgage payments. A yearslong struggle between the couple and its lenders ensued. Recently, the Levines were evicted from their house.
“We were in our house for 25 years. We don’t have plans to buy a house again,” Levine says. “Why did all this happen? Because we took out an equity loan and our mortgage was so high. Unless the business did well, we were never going to make the payments.”
Levine’s story shows the potential negative outcomes of using a HELOC to fund a business. Read on to learn more about this high-risk, high-reward funding method.
Is It a Good Idea To Use a HELOC for Your Business?
The negative aspects of using a HELOC for your business are clear: fail to make the payments, and you could end up losing your house.
“If you need to take money out for your business, putting personal collateral is very risky because if the business goes under, it’ll take down your personal finances also,” says Michael Foguth, founder of Foguth Financial Group, a financial planning service. “Using a HELOC becomes an idea when everything else for business lending has been exhausted.”
A HELOC is a way to get an infusion of cash without a lengthy application process, but it’s extremely risky since you’re putting your house on the line.
Foguth adds that current economic conditions have likely pushed more people to use HELOCs than in years past. With many businesses suffering due to the COVID-19 pandemic, home prices skyrocketing, and lenders being more open to taking credit files, it creates “almost a perfect storm.” While the risks of using a HELOC are clear, why are they so appealing?
“Applying for a HELOC is an easy process, and the funds are not monitored, meaning you have the flexibility to use them for your business as you see fit, whereas other business loans have restrictions,” says Sheraz Iftikhar, the president and CEO of Arch Global Advisors. “Using a HELOC to start your business might be a good idea, depending on your current situation and long-term goals … but financial experts caution you to weigh all the advantages and disadvantages before deciding.”
Pros and Cons of Using a HELOC for Business
There are no or few restrictions on using the funds, so they could be used to expand your business, acquire another one, or open up a franchise.
The HELOC allows access to capital without a lengthy loan process involved with major purchases. “HELOCs are set up as a revolving source of capital you can draw upon and repay as needed,” says Travis Forman, senior VP of Harbourfront Wealth Management and owner of Strategic Private Wealth Counsel.
Home prices are currently high and interest rates are low, leading to better terms for borrowers.
HELOCs are low cost and the debt can initially be paid off with interest only payments. When a business is profitable, the loan can be paid off without a prepayment penalty.
Loans terms will depend on the applicant’s credit or other factors in addition to a home’s equity.
Monthly interest payments are required.
Variable interest rates change, possibly leading to higher monthly interest payments.
Switching to another lender may not be possible until the HELOC and other debts are paid off.
Failure to pay monthly payments could ding your credit score and eventually diminish the value of your home or lead to foreclosure.
Alternatives to Using a HELOC for Your Business
If you’re not willing to bet your home on your business, good news: plenty of other options exist for business owners seeking funding.
“Now is the most opportune time for businesses to borrow money,” Foguth says.
For example, there’s loans from the Small Business Administration, including temporary programs such as the Economic Injury Disaster Loan, which Foguth says offers a 3.75% interest rate for 30 years. There’s also many business grants available.
“These are similar to a HELOC since your home is used as collateral, but it has fixed rates that are typically higher than HELOC rates and set deposits,” Iftikhar says. “Remember to compare the terms, rates, pros and cons, and consequences for defaulting on each option. If you’re overwhelmed by the various loan choices, you can always consult a broker or financial advisor who can help you figure out which option is best for you.”
Seeking a home equity line of credit should be considered a last resort option for funding your business, since you risk putting what is likely to be your most valuable asset, your home, on the line.
Be cautious of using a HELOC, and consider the ramifications. “Will you be able to pay at the current rates? You can’t count on your business doing well or doing better. If you’re going to take a HELOC, make sure you can make your payments for years,” Levine says.