Launching a new business is not a walk in the park, especially if you’re an early-stage entrepreneur with no capital and, worse, has a bad credit score. To ensure your dream becomes a reality, find a credible financing source, including bank loans, credit cards, and micro-lenders who finance individuals with low credit ratings.
However, some of these lenders, like banks, are not ready to finance startup ventures. Why? Because they are too green to run a business. They have little experience on their sleeves. So, banks are likely not to back them financially. This is where a home equity loan comes in. If you’re looking for startup capital, your home equity is perhaps the ideal source of funding to use. It is affordable too. But it comes with a risk. If your business doesn’t pick up financially or suddenly fails, you risk losing your home.
This doesn’t mean you can’t take advantage of your home equity to finance your venture. If you weigh out your options thoroughly, it is possible. This post will help you understand what a home equity loan is and how you can use it to tip the scales in your favor.
What’s a home equity loan?
When you use your home as collateral to secure a loan, that’s a home equity loan. However, the amount of the loan is dictated by the value of your home at the time. Or rather how much equity your home has accrued over a period. The difference between your home’s actual price or value and how much you pay as your mortgage is what is aptly referred to as equity. For instance, if the cost of your home is $400,000 and your mortgage is $300,000, your equity stands at $100,000. To get the actual valuation of your equity, use an online calculator.
The application process of a home equity loan is almost similar to that of a mortgage. Your debt-to-income ratio (DTI) and loan-to-value ratio (LTV) are considered when applying for a home equity loan. Your LTV must not exceed 85% and your DTI 43% to qualify. Besides your debt to income ratio and loan to value ratio, you also need to have a good credit score. So chances are slim of getting a home equity loan with a low credit score.
Advantages of financing your startup venture using a home equity loan
Though borrowing against your home is risky, it has its benefits. One of the benefits is low-cost prices. The home equity loan is reasonably priced than, say, getting a bank loan. Banks will slap you with high-interest rates, especially if you’re facing low credit ratings. Imagine having to pay a small business loan or any other loan at high interest rates ranging between 6% and 10%. These rates can escalate higher when you seek funding from private lending programs similar to this. Yet when you go the home equity loan way, your rates range between 4.25% and 6%.
It is no doubt this is the most affordable way to access capital for your startup venture. Though this intertwines your business activities and your personal activities, a home equity loan provides long-term capital for your business. And that’s fine.
Besides being cost-effective, a home equity loan provides you the flexibility to run your business. Also, the application process is not as tedious and time-consuming as that of a bank loan. In the case of the latter, the lender requires a business plan, future projections of your business in a number of years to come, even how much money flows into your account.
Risks involved when tapping home equity loan
You stand to lose your home
This is an indisputable fact. If your business fails or you default on payments, you risk losing your home. So it is necessary to know that regardless of the state of your business – whether it is making a profit or not – you have to repay the loan in due time. When you borrow against your home, it means you are ready to forfeit your home when you can’t afford to repay the debt. Banks are more willing to bet against your home than on the hope your business will succeed. So be careful before applying for a home equity loan.
Don’t gamble on your home if you are uncertain about the financial status of your business or if you are financially strained. The risks are higher if you can’t meet your monthly payments or if business isn’t too good.
No safety net when things go south, financially
A home is a valued asset, and most people know this. So when things go south financially – health issues, unemployment, etc. – your home acts as a safety net for you and your family. But when you borrow against your home, and with a poor credit rating to boot, your borrowing power diminishes especially when life throws you a curveball. You’ll be literally left with empty coffers to dip your hands into. And this will cost you a great deal.
Other funding options to consider
If you’re considering not applying for a home equity loan, there are different alternative ways to finance your startup capital, including:
Getting a small business loan – Forget the high-interest rates; a small business loan can see you through the success of your business without borrowing against your home. Then again, it allows for easy loan payments for a more extended period.
Looking for private lenders and investors – Find an investor who is generally interested in your idea. Convince them to fund your idea in exchange for a percentage of your business. This is a win-win situation.
Obtaining a collateralized loan – If your credit isn’t ideal, a collateralized loan may be the perfect thing for you. Although these types of loans require some form of collateral, they are attractive because of their easier approvals, fewer restrictions, and lower interest rates.
Seeking a personal loan – Though it has a borrowing limit, a personal loan comes with fixed interest rates. So, you’re sure of how much you’re paying and when.
Seeking a 401 (k) loan (retirement money) – Your 401 (k) balance is a credible funding source to use to get startup capital. But you’ll be gambling with your retirement money. And woe unto you if you are laid off or quit your job before making repayments, you risk losing your retirement money in the future. To some, this is better than losing a home.
It is no doubt a home equity loan is one of the best and reliable ways to finance your startup venture. It is affordable and provides room for flexibility when running your business. And compared to bank loans, a home equity loan allows you to enjoy low interest rates, which are attractive to borrowers. But there are risks involved in going the home equity way. Not only do you stand to lose your home, but also your financial safety net lowers. In other words, when you are financially strained with a bad credit score, you may end exhausting your cash reserves.
If you’re not ready to risk your home or borrow against your home, there are other alternative ways to fund your startup venture. You can choose to get a small business loan, seek help from a private lender or investor, get a personal loan, or to some extent, borrow against your retirement money. It is upon you to decide what suits you and your business best.