How to Get a Second Mortgage for Business

Starting a new business can be an exciting but daunting journey, especially in the first year. One effective way of funding your business is by taking out a second mortgage. A second mortgage allows you to access the equity in your home to get the funds you need for your business without paying the high rates typical of unsecured financing options. 


We’ll explain what second mortgages are, eligibility requirements, how to use them for business, and potential alternatives. We’ll also discuss whether a second mortgage is right for your business financing needs.

What is a Second Mortgage?

A second mortgage is a loan against equity in your home. It’s an additional loan on top of your first mortgage, with the loan amount based on the difference between your home’s appraised value and how much you owe on your mortgage. 

Second mortgages can be obtained as either a lump sum (home equity loans) or a line of credit (a home equity line of credit, or HELOC), with repayment terms and interest rates varying depending on the lender and loan terms.

How a Second Mortgage for Business Works

The process for getting a conventional second mortgage – not a HELOC – is very similar to getting a conventional mortgage. You start by finding a lender and applying. Once approved, you will receive the funds as a lump sum, which can be used for various business purposes, such as expanding or paying operating expenses. 

The repayment terms for a traditional second mortgage are typically fixed, requiring regular monthly payments. These payments are composed of both interest and principal, so the balance you owe will gradually decrease over time. 

These terms vary somewhat from a home equity line of credit (or HELOC), which functions as a revolving line of credit – similar to a credit card. However, HELOCs can also be used for business. 

Whether you use a HELOC or a home equity loan, it’s important to note that defaulting on the loan can result in the foreclosure of your home. Therefore, it’s crucial to carefully consider your ability to make timely repayments before opting for a second mortgage.

How to Get a Second Mortgage for Business

The first thing to do before applying for a second mortgage is to research the eligibility criteria and gather the required documentation. For example, you’ll need to make sure you have equity in your home that you can borrow against. You’ll also need to demonstrate your ability to repay the loan through W-2 income or established, reliable self-employment income (typically shown with two years of tax returns).

Next, you’ll want to research and compare lenders to find the best rates and terms. After you decide on a lender, submit an application and supporting documentation (a statement of debts, pay stubs, tax returns, etc.). 

When you submit your application, you’ll need to work with the lender to arrange an appraisal, provide any additional documentation, and take additional steps required for approval.

Once your loan is approved, you’ll set a closing date with the lender. This is when you’ll sign your loan documents, and loan funds will be distributed to you. You can then use the funds to start, grow, or operate your business.

Eligibility and Requirements for a Second Mortgage

You’ll need a good credit score (usually 680 or higher) to qualify for a second mortgage. Lenders also require a certain amount of equity in your home – most lenders only allow you to borrow 85% to 90% of your home’s value, less any existing balance on a first mortgage. 

You’ll also need proof of income and financial stability to demonstrate you can handle the additional debt. The lender will use this documentation to calculate your debt-to-income ratio, usually below 40% or so, to qualify for a loan. 

In some cases, an appraisal is necessary to determine the market value of your home. If an appraisal is necessary, you’ll usually need to pay an appraisal fee, which can be several hundred dollars.

Using a Second Mortgage for Business 

When you get a second mortgage, lenders typically don’t restrict how you can use the money (although some will prohibit you from using it for purely speculative purposes). If you need cash for your business, you can use funds from a second mortgage to invest in equipment, inventory, or real estate to support your business growth. 

What makes a second mortgage an attractive option for business financing is the potential for lower interest rates than available with other types of loans. You may not be able to deduct the interest expense (you can usually only deduct interest on a second mortgage if you use the money to buy or improve property). Still, you can deduct any business-related expenses you pay with the funds you borrow.

Pros and Cons of Using a Second Mortgage for Business

While a second mortgage can offer numerous benefits, such as lower rates and flexibility in using the funds, it’s important to weigh these against the potential risks and costs. Always consider your ability to repay the loan and the impact it could have on your personal finances and the financial health of your business.

Pros of Using a Second Mortgage to Fund Your Business

• High credit limits: Second mortgages allow you to borrow a significant amount of money – often more than a new business might qualify for with a conventional business loan. This can be particularly beneficial for businesses that need large amounts of capital for investments, expansions, or to cover other costs. 
• Low interest rates: Second mortgages typically offer lower rates than other loans or credit cards. This is because the loan is secured by your home, reducing the risk for the lender. 
• Flexible use of funds: Unlike some other types of loans, you can use the funds from a second mortgage for virtually any business purpose. Whether you need to invest in new equipment, hire more staff, expand your operations, or cover day-to-day expenses, a second mortgage gives you the flexibility to use the funds as you see fit.
• Potential tax benefits: While the interest on a second mortgage probably won’t be deductible if you use the funds for business, depending on how you use the funds, a second mortgage may allow you to pay tax-deductible business expenses.

Cons of Using a Second Mortgage for Business

• Increased risk of foreclosure: The most significant downside to using a second mortgage for business is the risk of foreclosure. If you can’t repay the loan, the lender can foreclose on your home. This risk underscores the importance of being confident in your ability to repay the loan before taking out a second mortgage.
• More debt: Taking out a second mortgage increases your overall debt load. This can put pressure on your finances. If your business runs into financial difficulties, this increased debt could exacerbate the problem and make it harder to secure additional financing.
• Fees and closing costs: Second mortgages come with several fees and closing costs. These include appraisal, origination, and legal fees, which need to be paid up-front or rolled into the loan.
• Reduced equity: A second mortgage reduces the equity you have in your home. This could affect your ability to sell or refinance your home in the future. It could also limit your options if you need to tap into your home equity for other purposes.

Alternatives to Second Mortgages for Business Financing

Before you take a second mortgage to fund your business, it’s important to explore alternatives. Some of the most common options are business loans, business credit cards, and venture capital, each offering advantages and disadvantages.

Business Loans

Traditional business loans offered by banks or credit unions are a common form of financing. These loans often require a solid business plan and financial records showing your business’s profitability. The loan interest rates, terms, and repayment schedules can vary depending on the lender and your business’s financial health. These loans also typically require a personal guarantee from the business’s owners, which can put your personal assets at risk.

Small Business Administration (SBA) Loans

The U.S. Small Business Administration offers a variety of loan programs designed to aid small businesses. These loans, usually long-term and with low interest rates, can be used for various business-related expenses. The SBA doesn’t lend money directly but guarantees a portion of qualified loans from participating banks, reducing the risk for lenders. These loans also require personal guarantees from anyone who owns 20% or more of the borrowing business.

Business Credit Cards

Business credit cards are also a quick and flexible source of funding that can be particularly useful for making small purchases, managing cash flow, or covering expenses while awaiting payment from customers. However, they often come with higher interest rates than other forms of financing, making them an expensive form of long-term financing.

Peer-to-Peer Lending

This form of financing connects borrowers with investors through online platforms. It offers an alternative for businesses that may not qualify for traditional loans. Interest rates vary but can be more favorable than traditional commercial loan rates. However, repayment terms can be strict, often requiring fixed monthly payments.

Crowdfunding

Crowdfunding platforms allow businesses to raise small amounts of money from a large number of people. This strategy can be an excellent way for startups or innovative businesses to secure funding. However, attracting contributors requires a compelling business idea and effective marketing.

Venture Capital

Venture capital is a type of private equity where investors provide funding to startups or small businesses that they believe have long-term growth potential. This method typically involves giving up a portion of equity or ownership in the business, but it doesn’t require collateral or monthly repayments.

When to Use a Second Mortgage for Business

Here are some situations where a second mortgage might be an appropriate choice for financing your business:

• Established equity: If you have a substantial amount of equity in your home, a second mortgage can offer a large sum of money for business financing. Depending on whether you get a home equity loan or a line of credit, you may be able to tap this equity repeatedly to fund growth or cover expenses over time.
• Low interest rates: Because they’re secured by your home, the interest rates for second mortgages are typically lower than credit cards and personal loans.
• Business stability: If your business is stable and has a consistent revenue stream, the regular payments of a second mortgage could be manageable and save you considerable interest expense compared to a credit card or other type of high-interest financing. 
• Long-term investment: If the business funding is for long-term investments you expect to yield high returns, a second mortgage may be a good option. 
• Poor business credit: Getting approved for traditional business loans can be challenging if your business is relatively new or has a poor credit history. Using a second mortgage lets you leverage your personal assets and credit to help fund your business.

In some instances, a second mortgage can be an excellent way for self-employed individuals and small business owners to fund their businesses. Second mortgages provide quick access to capital by leveraging your property’s equity. However, before pursuing this route, consider the eligibility requirements and the increased risk of foreclosure. If you’re unsure whether a second mortgage is right for you, contact an accountant or financial advisor to learn more about your options.