About 15 years ago, Barry Levine was offered a $ 200,000 loan to borrow ushae at will. All he had to do was bet his house that he could repay it.
The La Jolla, California-based entrepreneur and his wife planned to use the funds from the Home Equity Line of Credit (HELOC), a loan backed by a home’s equity, to increase his 30-year-old temperature reading Camera maker Sperry West. He hired a professional marketing manager, a VP of Sales and three sales people.
“We implemented the plan – 100 percent of the equity went into the business,” he says. “We haven’t spent any of this on ourselves.”
But things didn’t go as planned after his new hires failed to meet the company’s goals.
The Levines could no longer afford to pay their monthly mortgage payments of $ 12,000 to $ 13,000. A year-long struggle ensued between the couple and their lenders. The Levines were recently evicted from their home.
“We were in our house for 25 years. We have no plans to buy another house, ”says Levine. “Why did this all happen? Because we took out an equity loan and our mortgage was so high. If business didn’t go well, we’d never make the payments. “
Levine’s story highlights the potential negative consequences of using a HELOC to fund a business. Read on to learn more about this high risk and rewarding 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: if you fail to make the payments, you can lose your home.
“If you need to withdraw cash for your business, putting up personal collateral is very risky because if the business collapses, your personal finances will be destroyed too,” said Michael Foguth, founder of Foguth Financial Group, a financial planning service. “Using a HELOC becomes an idea when everything else for corporate lending is exhausted.”
Pro tip
A HELOC is a way to get an infusion of cash without a lengthy application process, but it’s extremely risky as you are putting your house at risk.
Foguth adds that current economic conditions have likely driven more people to use HELOCs than in previous years. With many businesses suffering from the COVID-19 pandemic, house prices skyrocketing, and lenders more open to taking credit files, “almost a perfect storm” is emerging. While the risks of using a HELOC are clear, why are they so attractive?
“Applying for a HELOC is a straightforward process and funds are not monitored, which means you have the flexibility to use them however you want for your business, while other business loans are restricted,” said Sheraz Iftikhar, President and CEO of Arch Global Advisors. “Using a HELOC to start your business can be a good idea, depending on your current situation and your long-term goals … but financial experts warn you to weigh all the pros and cons before making your decision.”
Advantages and disadvantages of using a HELOC for business
advantages
There are no or few restrictions on how the funds are used, so they can be used to expand your business, acquire another, or open a franchise.
The HELOC enables access to capital without the lengthy credit process associated with major purchases. “HELOCs are set up as a source of revolving capital that you can fall back on and repay when you need to,” said Travis Forman, senior VP of Harbourfront Wealth Management and owner of Strategic Private Wealth Counsel.
Real estate prices are currently high and interest rates are low, resulting in better terms for borrowers.
HELOCs are inexpensive and debts can initially only be settled with interest payments. If a business is profitable, the loan can be paid off with no prepayment penalty.
disadvantage
The loan terms depend on the applicant’s creditworthiness or other factors in addition to the home equity.
Monthly interest payments are required.
Floating interest rates change, potentially leading to higher monthly interest payments.
Switching to another lender may not be possible until the HELOC and other debts have been paid.
Failure to make the monthly payments can affect your creditworthiness and eventually decrease the value of your home or lead to foreclosure.
Alternatives to using a HELOC for your company
If you’re not ready to put your home on your business, great news, there are plenty of other options for business owners looking for funding.
“Now is the best time for companies to borrow money,” says Foguth.
For example, there are Small Business Administration loans, including fixed-term programs like the Economic Injury Disaster Loan, which Foguth says offers a 3.75% interest rate for 30 years. There is also a lot of business development.
Of course, there are also more traditional funding routes such as personal loans, small business credit cards, secured or unsecured business loans, or a home loan.
“These are similar to a HELOC in that your house is used as collateral, but it has fixed interest rates that are usually higher than HELOC and fixed deposits,” says Iftikhar. “Remember to compare the terms, prices, pros and cons, and consequences of defaulting each option. If you are overwhelmed by the various loan options, there is always a need to consult a broker or financial advisor who can help you find the best option for you. “
Bottom line
Finding a home equity line of credit should be viewed as a last resort in financing your business as you risk putting your most valuable asset, your home, at risk.
Be careful about using a HELOC and consider the implications. “Can you pay at the current rates? You cannot rely on your business to be doing well or any better. When you take a HELOC, you make sure that you can make your payments for years, ”says Levine.
