Using a HELOC for Business: Risks and Considerations
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About 15 years ago, Barry Levine was offered a loan of $ 200,000 to use as he saw fit. All he had to do was bet his house that he would be able to pay it off.
The La Jolla, Calif.-Based entrepreneur and his wife planned to use funds from the Home Equity Line of Credit (HELOC), a loan backed by the equity of a home, to increase his temperature reading 30 years old. camera manufacturing company, Sperry West. He hired a professional marketing director, a vice president of sales and three salespeople.
“We executed the plan – 100% of the home equity money was invested in the business,” he says. “We didn’t spend anything on ourselves.
But things did not turn out the way they planned after his new hires failed to meet company goals.
The Levins could no longer afford their huge monthly mortgage payments of $ 12,000 to $ 13,000. A multi-year struggle between the couple and their lenders ensued. Recently the Levines were evicted from their home.
“We had been in our house for 25 years. We don’t plan to buy a house again, ”says Levine. “Why did all this happen? Because we took out an equity loan and our mortgage was so high. Unless the business was doing well, we were never going to make the payments. “
Levine’s story shows the potential negative results of using a HELOC to fund a business. Read on to learn more about this high-risk, high-yield financing method.
Is it a good idea to use a HELOC for your business?
The negatives of using a HELOC for your business are clear: Fail to make payments and you could end up losing your home.
“If you have to withdraw money for your business, putting personal guarantees is very risky, because if the business goes bankrupt, your personal finances will also be destroyed,” says Michael Foguth, founder of Foguth Financial Group, a financial planning. . “Using a HELOC becomes an idea when everything else for business loans has been exhausted. “
A HELOC is a way to get a cash injection without a lengthy application process, but it is extremely risky since you are putting your home at risk.
Foguth adds that current economic conditions have likely caused more people to use HELOCs than in the past. With many businesses suffering from the COVID-19 pandemic, soaring house prices and lenders more open to taking on credit reports, this is creating “an almost perfect storm.” While the risks of using a HELOC are clear, why are they so attractive?
“Applying for a HELOC is an easy process and the funds are unmonitored, which means you have the flexibility to use them for your business as you see fit, while other business loans have restrictions,” says Sheraz Iftikhar. , President and CEO of Arch Global Advisors. “Using a HELOC to start your business may be a good idea, depending on your current situation and long-term goals… but financial experts advise you to weigh all the pros and cons before deciding. “
Advantages and disadvantages of using a HELOC for businesses
There are no or few restrictions on how the funds are used, so they could be used to grow your business, acquire another, or open a franchise.
HELOC provides access to capital without a lengthy loan process associated with large purchases. “HELOCs are designed as a source of revolving capital that you can draw on and repay as needed,” says Travis Forman, senior vice president of Harbourfront Wealth Management and owner of Strategic Private Wealth Counsel.
House prices are currently high and interest rates are low, which allows better terms for borrowers.
HELOCs are inexpensive and debt can initially be repaid with interest payments only. When a business is profitable, the loan can be repaid without a prepayment penalty.
The terms of the loans will depend on the applicant’s credit or other factors in addition to the equity in a home.
Monthly interest payments are required.
Variable interest rates change, which can result in higher monthly interest payments.
Switching to another lender may not be possible until the HELOC and other debts are repaid.
Failure to pay monthly payments could hurt your credit score and potentially lower the value of your home or lead to foreclosure.
Alternatives to using a HELOC for your business
If you’re not ready to bet your home on your business, the good news is that there are plenty of other options for business owners looking for financing.
“Now is the best time for businesses to borrow money,” Foguth said.
For example, there are Small Business Administration loans, including temporary programs like the Economic Disaster Loan, which Foguth says offers an interest rate of 3.75% for 30 years. There are also many business grants.
Of course, there are also more traditional avenues of financing such as personal loans, small business credit cards, secured or unsecured business loans, or a home equity loan.
“These are similar to a HELOC since your home is used as collateral, but it has fixed rates which are generally higher than HELOC rates and fixed deposits,” says Iftikhar. “Remember to compare the terms, rates, pros and cons and consequences of defaulting on each option. If you are overwhelmed by the various loan choices, you can always consult a broker or financial advisor who can help you determine which option is best for you.
Finding a home equity line of credit should be seen as a last resort option to finance your business because you risk putting what is likely to be your most valuable asset, your home, at risk.
Be careful when using a HELOC and consider the ramifications. “Will you be able to pay at current rates? You cannot count on the success or improvement of your business. If you are considering taking a HELOC, make sure you can make your payments for years to come, ”says Levine.