Home equity hit record highs during the Covid pandemic, with the average American homeowner sitting on over $170K of tappable equity at the end of 2021.
At the same time, a record 500,000 Americans became unincorporated self-employed workers.
Of course, it costs a lot of money to start and run a business. Which leaves many wondering, can you tap into that pent-up home equity to fund a new business venture?
The short answer is yes. But you should explore your options carefully and make sure it’s a sound financial move. Here’s what to do.
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Given that most banks are notoriously shy about lending to startups, you may have to rely on your own funding. For many, that means tapping into home equity.
Generally, when you withdraw home equity, there are no specific rules about how you can spend the funds. So you’re free to use the cash for any business-related purposes.
There are a few basic steps to get started:
Things are a little easier if you wish to buy an existing business. You’ll then have a much better idea of future cash flow. But you’ll want to have a business accountant look over the latest audited accounts and recent day-to-day numbers.
There are three main loan types that allow you to tap home equity to start a new business. These include:
Research your options carefully and talk to a loan officer about the pros and cons of each one. It’s likely one of the three loan types will be better suited to your situation than the others.
This is a key point: If you want to use home equity to fund a new business, you likely need to apply for the loan before you quit your current job and set out on a new venture.
You’re more likely to get your application approved if you apply while you’re still an employee. Because you can show a consistent income and a solid record of employment.
If you wait until after you’ve resigned from your current post, you won’t be able to prove that you can comfortably afford your monthly payments. And few — if any — mainstream lenders will touch you.
As a rule of thumb, self-employed borrowers usually need a two-year history of self-employment income to get approved for a loan. (Though in some circumstances one year is enough.) If you quit your job and then try to apply for home equity financing right away, there’s a good chance you’ll be out of luck.
There are some real benefits to using home equity for a business startup — as well as some serious pitfalls. Here’s what you should consider before taking the leap.
The main advantage of using home equity to start a new business is that it often gives you a large sum.
How much you can get will depend on how long you’ve owned your home and the property market where it’s located. But many find that a cash-out refinance or a second mortgage provides more cash than any other form of borrowing open to them.
The other big advantage of home equity financing is that interest rates are low compared to other types of borrowing.
At the time this was written in Feb. 2022, mortgage rates were rising to the high-3% and low-4% range. Though much higher than the record lows seen in 2020 and 2021, those rates are still incredibly low compared to options like a personal loan or small business loan.
The biggest risk of home equity financing is that any sort of mortgage requires you to put your home on the line. And, if you fall too far behind with your payments, you could face foreclosure.
So it’s worth exploring other, unsecured, borrowing options and seeing how they compare to a mortgage.
You might still be in trouble if your venture goes bad. But at least those unsecured lenders can’t directly go after your home, even if their interest rates are higher.
None of this would matter if you were guaranteed success. And, presumably, all entrepreneurs believe their startups stand a good chance of thriving. But there are some real challenges to be aware of.
According to the US Small Business Administration, “About two-thirds of businesses with employees survive at least 2 years and about half survive at least 5 years.” That statement was from 2012. But 2021 data from the Bureau of Labor Statistics suggest things haven’t changed much since then.
Of course, that doesn’t mean your venture will fail. And many small businesses are a genuinely good investment.
These stats are only meant to underscore the riskiness of tying your home to a new business. You want to be absolutely sure that, even in a worst-case scenario, you’ll be able to make your mortgage payments and your house won’t be in jeopardy.
If you try for a personal loan or small business loan, the first thing a bank will ask for is your business plan. And one of those is essential, even if you’re not borrowing at all.
The discipline of writing a business plan will cause you to question your own assumptions. And it will force you to see your new venture in a more rounded way. You’ll also have to make financial projections, which might give you some surprising insights.
The U.S. Small Business Administration provides guidance about business plans. And there are sample plans at that link, too.
So write yours. And then show it to friends who are entrepreneurs or business professionals. Get them to pick it apart. You want to identify potential problems as early as possible so you can address them.
Going through that process can give you real confidence in the soundness of your venture. And that, in turn, can make it much less stressful and scary when you tap your home equity to start a new business.
With home values near record highs, it’s a fruitful time for homeowners to tap their equity.
Using those funds to start or improve a business venture could be the right move, as long as you consider all your options carefully and have your financial plan clearly outlined.
If you’re ready to take the next steps, connect with a mortgage lender who can check your eligibility and give you a quote for home much equity you’re eligible to borrow. You can get started right here.
© Copyright Full Beaker, Inc. 2022