HELOCs Are Great For Many Things. Starting a Business Isn’t One

An image of two people working at a store is used to illustrate an article about using a home equity loan to start a business. Credit: Getty Images
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Homeowners are sitting on potential opportunities – but they aren’t all worth taking.

Home values have risen dramatically in the last few years. That means homeowners have much more equity – an average increase of $60,200 in the past year as of the second quarter of 2022, according to data from CoreLogic.

Many homeowners have taken advantage of that equity to borrow money using home equity loans or lines of credit (HELOCs) for big-ticket projects like renovations. But some people may have bigger plans, like using their home equity to start a business or fund a startup. And with a bigger potential pot of equity to borrow against, now just may be the time to take action. 

Homeowners looking at using their equity to start businesses should think long and hard before doing so, says Tim McGrath, CFP, managing partner at Riverpoint Wealth Management in Chicago. 

“Everybody who starts a business thinks that they won’t fail,” McGrath says, adding that prospective entrepreneurs would do well to consider the pros, cons, and risks prior to tapping their equity — and to think about alternatives that won’t put your home at risk.

Understanding Home Equity

Before considering whether borrowing against your home to fund a business is a good idea, make sure you understand the ins and outs of home equity.

Home equity – the difference between a home’s market value and the remaining balance on a buyer’s mortgage – can be used as collateral for a home equity line of credit (HELOC). Homeowners can use a HELOC almost like a credit card, as it’s a revolving line of credit. You’ll 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 tap into equity, as there are few costs to do so,” says Nicole Rueth, producing branch manager with the Rueth Team Powered by OneTrust Home Loans.

Home equity loans are another way to borrow, but they’re lump-sum loans. You borrow a certain amount and pay it back in set installments, usually at a fixed interest rate.

Pro Tip

Remember that HELOCs often have variable interest rates, meaning that your minimum monthly payments may not always be the same. During a time 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 fund a new business, so if you’re a homeowner who’s benefitted from an increase in home values, it is one avenue of potential funding that you can explore. And since a HELOC is a revolving line of credit (once again, much like a credit card), you can use it when you need to, rather than taking out a large lump-sum of cash via a home equity loan.

What can you use a HELOC to pay for? Just about everything, as there are few, if any, restrictions. The money could be used to pay for equipment, office space, staffing and other costs.

There are many more expenses related to starting a business, but HELOCs can help you knock most of them out. But remember: The funds are being borrowed against 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 advantages and disadvantages when it comes to paying for business startup costs. 

Pros

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

HELOCs also tend to have low associated costs and rates. “The rates on HELOCs have been very attractive, traditionally,” says McGrath. They’re also fairly easy to access. Getting a big loan (like a mortgage) can be an arduous process, but HELOCs are relatively quick to get because you already own the home.

Cons

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

Interest rates for HELOCs are variable – and they’re rising as the Federal Reserve raises its rate to combat high inflation. That can make your payments more expensive even if you don’t borrow more money, affecting your monthly budget in ways that are outside of your control.

The biggest downside to borrowing against home equity is the risk: If you fail to make your payments, you could be looking at serious consequences as a homeowner. Worst case scenario? Your home is foreclosed.

Pros

  • The equity is there

  • Low costs

  • Easy to access

Cons

  • Harder to budget

  • Changing interest rates

  • Your home is at risk

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 brass tacks: Is using a HELOC to open a business a good idea? Experts tend to lean toward finding other sources of funding if you plan to start a business, given the risks involved.

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

Prospective business owners should try to find other funding sources before tapping their equity. “Look to see if there are any other sources of equity or money,” McGrath says. That could include business loans, personal loans, or even a small business line of credit. “We’ve seen so many clients stick money in 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. At the end of the day, he says, the risks are simply 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 were to take money out of your home to start a business and it fails, you have some real problems.”