How To Use A HELOC To Advance Your Business

A home equity line of credit (HELOC) is a financial tool that allows homeowners to leverage the equity in their home. Homeowners doubling as entrepreneurs or business owners can utilize HELOCs to fund a business venture, pay for property, purchase equipment or inventory, or bolster cash flow during slower cycles.

While a HELOC can be a powerful vehicle for business growth, it demands careful strategic planning and financial discipline.

How Does Using HELOC To Start a Business Work?

Using a HELOC can be an effective way for entrepreneurs to start or advance their business ventures. It gives them the ability to tap into extra cash—up to a specific limit—which they can use for various startup costs such as purchasing equipment or investing in advertising. HELOC rates are also competitive relative to other forms of lending.

The revolving nature of the credit line means entrepreneurs and business owners alike can draw money as needed, providing flexibility to effectively manage their cash flow. You’ll only make payments on what you borrow—not the total credit line. During the HELOC’s draw period, you may only need to pay interest, which can ease the financial burden during a business’s early stages.

Is Using a HELOC To Start a Business Risky?

Utilizing a HELOC to fund a business venture comes with inherent risks, primarily because your home secures the loan. If the business fails to generate expected revenue and you default on the HELOC, your home could be foreclosed on. As an entrepreneur, you must recognize that by intertwining personal assets with business financing, you risk jeopardizing your personal financial security. Approach this strategy cautiously.

Pros and Cons of Using a HELOC for Your Business

Understanding the pros and cons of using a HELOC to advance your business is crucial when choosing a financial strategy that aligns with your long-term business goals. These are some of the key benefits and drawbacks to consider.

Pros of Using a HELOC for Your Business

• Lower interest rates. HELOCs typically have lower interest rates than credit cards or unsecured personal loans because your home equity secures them. This can significantly reduce financing costs over time.
• Flexible borrowing options. Unlike traditional loans, a HELOC provides a revolving credit line you can draw from as needed. Such flexibility makes it easier to manage cash flow because you only pay for what you borrow, and you only borrow what you need when you need it.
• Interest-only payments. During the draw period of a HELOC, you may have the option to make interest-only payments. This can provide temporary relief from larger payments and help businesses currently in the growth phase.
• Continued ownership. Using a HELOC avoids the need to raise funds by diluting ownership through equity financing. You retain complete control of your business while funding it.
• Access to large amounts of capital. With a HELOC, you can access substantial sums of money, depending on your home equity. Doing so can be critical for more significant investments or unexpected business expenses.
• Ease of use. Once approved for a HELOC, you can draw funds quickly, often through checks or a card connected to the line of credit. This makes it a convenient way to access funds as needed.

Cons of Using a HELOC for Your Business

• Risk of foreclosure. If you fail to make payments on your HELOC, you risk losing your home because it’s collateral for the credit line.
• Variable interest rates. HELOCs commonly have variable interest rates, which means your payments could increase if interest rates rise.
• Impact on personal credit. Borrowing against home equity can significantly affect your personal credit and borrowing capacity for other personal needs or investments.
• Limited borrowing based on equity. HELOC borrowing limits are restricted by the amount of equity in your home, which may not be sufficient for your business needs.
• Fluctuating home values. Changes in the housing market can affect the amount of equity available. They also may influence your ability to borrow additional funds if needed.
• Potential for misuse. The ease of accessing funds can lead to mismanagement or unnecessary expenditures that do not ultimately benefit the business.

Alternatives to a HELOC for Financing Your Business

Exploring alternatives to a HELOC is critical for business owners who want to minimize personal financial risk or who may not have enough equity in their homes. These are some popular financing options that can offer the capital needed to grow or sustain a business—without tapping into home equity.

Term Loans

These are traditional business loans from banks or credit unions, offering a lump sum of capital that you’ll pay back over a set period of time. Term loans tend to have fixed interest rates and predictable monthly payments, which can help with budgeting and planning. Getting approved may require a solid business plan, a strong credit history and collateral.

Small Business Administration Loans

The Small Business Administration (SBA) offers various loan programs for small businesses that struggle to qualify for traditional bank loans. SBA loans are typically easier to qualify for and have lower interest rates and longer repayment terms. However, the application process can be lengthy, and stringent usage restrictions may apply.

Online Business Loans

For faster funding, online lenders provide various loan products with a more straightforward application process and quicker turnaround times than traditional banks. The trade-off can come in the form of higher interest rates and fees, making it essential to weigh the cost against the convenience.

Venture Capital and Angel Investors

Companies with high-growth potential might attract venture capitalists or angel investors willing to provide funding for a share of equity. This can be advantageous for businesses that don’t have collateral or prefer not to take on debt. Still, it means sharing ownership and sometimes control of the business.

Reward-Based Crowdfunding

Crowdfunding platforms, like Kickstarter, allow businesses to raise funds by preselling a product or offering rewards to backers. This not only provides capital but also validates the product in the marketplace. However, it may take a considerable marketing effort to reach funding goals.

Related: Equity Crowdfunding: What Is It & How Does It Work?

Invoice Factoring

Invoice factoring is when a business sells outstanding invoices to a third party at a discount in exchange for immediate funds. It can provide a quick cash flow boost, but businesses sacrifice a portion of their profits and potentially expose their client relationships to a third party.

Personal Loans

A personal loan may be viable for small-scale funding needs without putting your home at risk. Nevertheless, the personal financial impact is still significant because the loan is tied to your creditworthiness, and failure to repay could damage your credit score and future borrowing capability. In addition, personal loans tend to have higher interest rates than HELOCs.

Business Lines of Credit

Similar to HELOCs, these unsecured lines of credit provide flexibility in borrowing but are based on the business’s creditworthiness rather than home equity. These often have higher interest rates compared to HELOCs, but you’ll avoid putting personal property at risk.

Frequently Asked Questions (FAQs)