How to Use a HELOC for Business

A home equity line of credit is a type of financing that’s secured by residential property you own. If you own a home and need funding to start or grow your business, a HELOC can be a great way to get quick access to cash to help fund your business. 

In this article, we’ll explore all the ins and outs of using a HELOC for your business. We will evaluate the pros and cons, compare it with other financing options, and discuss the steps needed to qualify for a HELOC. We’ll also discuss when to use a HELOC for business purposes and explain what happens to your business if you fail to repay the HELOC.



What Is a HELOC for Business?

A HELOC is a loan secured by your home and used to help fund the operation or growth of a business. HELOCs differ from other types of loans because you don’t typically borrow all of the money at once, and you only pay interest on the portion you borrow. Payments are also usually interest-only. 

This type of financing option is a great option for funding a new small business because it’s extremely flexible. However, it’s important to remember that because the loan is secured against your home, failure to repay could result in loss of your property. 

How Does a HELOC for Business Work?

A HELOC works very similarly to a credit card. You start by applying for a loan based on your income and the value of your home. If you’re approved, the lender sets a borrowing limit based on the equity you have in your home. You can borrow up to this limit as needed, repay, and re-borrow again. Payments are typically interest-only as long as you’re in the draw period (the time when you can borrow against the line).

Eventually – typically after five or 10 years – the draw period ends, and the HELOC enters the repayment period. During this time – typically lasting from 5 to 20 years – you make regular fixed monthly payments of both the principal and interest payments, similar to a conventional mortgage. 

During the draw period, interest rates for HELOCs are usually variable – a few points over the prime rate is typical. However, some lenders may offer the option to convert a variable rate to a fixed rate during the loan term. 

The Pros and Cons of Using a HELOC for Business

While HELOCs can provide valuable liquidity and flexibility for businesses, they also carry certain risks, particularly given their link to the business owner’s home. Below are some pros and cons of using a HELOC for your business.

Pros of Using a HELOC for Business

• Access to large capital: A HELOC can provide a substantial amount of money, dependent on the equity of your home. When you’re first starting your business, initial costs can be high, and a larger HELOC may help you avoid having to apply for multiple loans.
• Flexibility in fund use: Unlike some specific business loans, you can use the funds from a HELOC for virtually any business expense. This flexibility can benefit a young business facing unexpected costs or needing to pivot quickly.
• Lower interest rates: Generally, the interest rates for a HELOC are lower than those of credit cards or unsecured personal loans. 
• Interest-only payments: During the draw period, you only pay interest on the funds you’ve borrowed against your HELOC.
• Potential tax benefits: If you use the funds drawn from the HELOC for business purposes, the interest paid on those funds may be tax-deductible.
• Revolving credit: A HELOC is a revolving line of credit, meaning you can borrow, repay, and then borrow the same funds again as needed.

Cons of Using a HELOC for Business

• Risk of losing your home: As a secured loan, a HELOC uses your home as collateral. If you cannot make the required payments, you risk losing your home to foreclosure. 
• Fluctuating interest rates: HELOCs typically have variable interest rates, meaning your payments could increase over time. Although they start lower than rates for other types of credit, this variability could lead to higher costs in the long run.
• Impact on personal credit: If your business struggles and you’re unable to pay back the HELOC, your personal credit score will be negatively impacted. This can hinder your ability to obtain financing in the future, not only for your business but also for your personal needs.
• Fees and penalties: There can be various fees associated with a HELOC, including origination fees, annual fees, and prepayment penalties. 
• Potential loss of tax benefits: The interest paid on a HELOC is only tax-deductible if you use the funds to buy, build, or substantially improve the home that secures the loan. If the funds are used for other business expenses, you may be able to deduct the business expenses but not the interest charges.

Other Financing Options

A HELOC is not the only way to fund a business. Two other types of financing that business owners and self-employed people commonly use to fund their businesses are credit cards and personal loans. Both types of financing are unsecured, offering slightly less risky ways to finance a business. However, they may also come with higher costs and other risks.

HELOC vs. Credit Cards

HELOCs generally offer lower interest rates compared to credit cards and higher credit limits compared to most credit cards. However, credit cards may come with rewards or cashback options that HELOCs don’t provide. The biggest difference is that because credit cards are unsecured, failure to pay a credit card debt won’t lead to foreclosure on your home.

HELOC vs. Personal Loans

Because HELOCs function as revolving lines of credit, they allow you to borrow only the amount you need and to pay interest on that amount. Personal loans, however, distribute the total amount of a loan upfront. Payments are then made monthly, composed of both principal and interest. And, because HELOCs are secured and personal loans typically aren’t, personal loans usually have higher interest rates. 

How to Qualify for a HELOC 

Qualifying for a HELOC can be an effective way to access much-needed funds. However, securing a HELOC can be complex – especially for self-employed individuals. Here are some of the things you’ll need to qualify for a HELOC:

• Sufficient home equity: A primary requirement for a HELOC is having sufficient equity in your home. Lenders typically allow you to borrow up to a total of 85% to 90% of your home’s value minus the amount you owe on your mortgage.
• Good credit score: The minimum credit score for a HELOC varies among lenders, but a score above 680 is a common requirement. A score over 740 typically qualifies you for better rates.
• Stable income: Lenders need to know that you have a reliable source of income. If you’re still working a traditional job and running your own business, this could be from your job, business, or other verified sources. Lenders may request proof of income through pay stubs, tax returns, or bank statements.
• Low debt-to-income ratio (DTI): Lenders will calculate your DTI by dividing your monthly debt payments by your gross monthly income. This number gives lenders an idea of whether you can afford more debt. A DTI ratio of 43% or less is generally considered good by most lenders.

When to use a HELOC for Business

HELOCs can be a suitable financing option for small businesses with stable income. However, startups may face challenges in qualifying due to limited credit history and a lack of steady, established income. Businesses with inconsistent income may struggle with regular payments. 

Generally, the best time to use a HELOC is when you’re just starting your business and still working a full-time job, as this will make it easier to demonstrate an ability to repay the loan. If you wait until you leave your job and are just starting to focus on your business full-time, qualifying may be much harder.

What Happens if You Fail to Repay the HELOC?

Failure to repay a HELOC can lead to your lender foreclosing on your home. It can also cause serious damage to your credit. While these may not directly impact your ability to operate your business, they can have considerable long-term financial impacts. If you’re struggling to repay a HELOC, it’s crucial to communicate with your lender and negotiate a new payment plan to help you stay current.

Using a HELOC for business can provide flexibility and access to funds for various business needs. However, it is essential to carefully evaluate the pros and cons before making a decision. Consider the benefits and risks before deciding whether to use a HELOC to fund your small business.