Should You Use Home Equity to Buy a Business?

For many experienced professionals, one of their largest financial assets is not sitting in a bank account.

It is in their home.

Years of mortgage payments, appreciation, and homeownership may create substantial equity.

When business ownership enters the conversation, that can lead to an obvious question:

Home equity may provide access to capital through structures such as a home equity line of credit, home equity loan, or cash-out refinance.

Depending on the circumstances, that capital may potentially become part of a broader business funding strategy.

But home equity carries a characteristic that makes it fundamentally different from ordinary unsecured borrowing:

Your home may secure the debt.

That makes the decision much broader than comparing interest rates.

Home Equity Is One Funding Option Among Several

Home equity should generally be evaluated within the broader question of how to fund a business.

Other potential sources may include:

• Personal cash
• SBA-backed financing
• Conventional business financing
• Eligible retirement-based funding structures
• Equipment financing
• Investor capital
• Other appropriate sources

The right question is therefore not simply:

It is:

What Is Home Equity?

Home equity is generally the difference between the value of a property and the debt secured by it.

Having Equity Does Not Mean All of It Is Available

A homeowner may have substantial equity without being able—or wanting—to borrow all of it.

Lenders may consider factors such as:

• Property value
• Existing mortgage balance
• Loan-to-value limits
• Income
• Credit profile
• Debt obligations
• Employment or income documentation
• Property type

There is therefore an important distinction between:

Common Ways to Access Home Equity

Homeowners may encounter several potential structures.

Home Equity Line of Credit — HELOC

A HELOC generally provides a revolving line of credit secured by the home.

Depending on the terms, borrowers may draw funds as needed up to an approved limit.

Potential characteristics may include:

• Revolving access to funds
• Variable interest rates
• A defined draw period
• A subsequent repayment period
• Payments that may change as rates or balances change

Home Equity Loan

A home equity loan generally provides a lump-sum amount secured by the residence.

Depending on the lender and product, the loan may have a fixed interest rate and defined repayment schedule.

Cash-Out Refinance

A cash-out refinance generally replaces an existing mortgage with a new mortgage for a larger amount.

The homeowner receives part of the difference in cash, subject to lender requirements and transaction costs.

Because the original mortgage is replaced, this structure may affect:

• Interest rate
• Monthly payment
• Loan term
• Closing costs
• Total long-term borrowing cost

HELOC vs. Home Equity Loan vs. Cash-Out Refinance

The availability, rates, terms, fees, tax treatment, and suitability of these structures vary.

A qualified mortgage or lending professional can explain how specific products work in an individual situation.

The Central Tradeoff: Business Capital vs. Household Collateral

The primary benefit of home equity is straightforward:

It may unlock capital that is otherwise tied up in a non-liquid asset.

The primary risk is equally important:

The borrowing is generally secured by the home.

That means a business-funding decision can become connected directly to household housing security.

The Elevare Home Equity Risk Framework

Home Equity Does Not Replace a Total Capital Plan

Accessing $100,000 from home equity does not answer whether $100,000 is the correct amount to put into the business.

Before choosing the funding source, first determine the total capital requirement for business ownership.

That broader requirement may include:

• Acquisition or startup capital
• Business working capital
• Personal reserves
• Contingency capital

Home-equity borrowing is one possible answer to:

It should not replace the prior question:

Do Not Use Household Reserves Twice

A common capital-planning problem occurs when home equity is mentally assigned to several different purposes.

Someone may think:

• I can use my HELOC to fund the business.
• I can also use the HELOC if the household has an emergency.
• I can also use the HELOC if the business needs additional working capital.

But those are three different financial needs relying on the same borrowing capacity.

If the line is already heavily drawn for the business, it may no longer be available for a household or business emergency.

Home Equity Is Not the Same as Personal Reserve

This distinction is particularly important.

A personal reserve is generally capital intended to support household expenses during the ownership transition.

A HELOC or home equity loan is borrowed money.

Borrowed money creates:

• Interest expense
• Repayment obligations
• Potentially changing payments
• Additional debt secured by the home

Our guide to personal reserves for business ownership explains why household runway deserves to be evaluated separately from available borrowing capacity.

Home Equity Does Not Eliminate Working-Capital Needs

A business can be fully funded for startup and still need substantial operating capital after launch.

That may include money for:

• Payroll
• Marketing
• Rent
• Inventory
• Technology
• Insurance
• Other operating expenses

Our guide to understanding working capital explains why the operating runway should be calculated separately from the startup investment.

Debt Service Changes the Business and Household Economics

Home-equity borrowing creates an additional payment obligation.

Depending on how the debt is structured and paid, that obligation may affect:

• Household monthly expenses
• Business cash-flow requirements
• Working-capital needs
• Owner compensation requirements
• Personal reserve needs

This can create an important feedback loop.

Interest-Rate Risk Can Matter

Some home-equity products may have variable interest rates.

If rates increase, the cost of borrowing may also increase.

When evaluating the financing, consider:

• Is the rate fixed or variable?
• How often can it change?
• Is there a maximum rate?
• How would a higher rate affect the monthly payment?
• Could the business and household still support the debt?

A funding strategy that works only at the introductory or current interest rate may deserve additional stress-testing.

Payment Structure Matters

Different home-equity products may have different repayment structures.

For example, a HELOC may have one payment structure during the draw period and another when repayment begins.

Prospective borrowers should understand:

• When principal repayment begins
• Whether payments can increase
• How long the repayment period lasts
• Whether balloon or maturity provisions apply
• What happens if the line is frozen or reduced

The complete repayment structure matters more than the initial monthly payment.

Do Not Assume the Tax Treatment

The tax treatment of home-equity interest can depend on current law, use of proceeds, individual circumstances, and other factors.

Do not assume that interest will be deductible simply because the loan is secured by a home or used in connection with a business.

A qualified tax professional should evaluate the tax treatment for your circumstances.

Home Equity vs. SBA Financing

Home-equity borrowing and SBA-backed financing create different structures.

Neither structure is automatically superior.

The appropriate choice depends on the complete ownership plan, financing terms, liquidity, risk tolerance, business economics, and household circumstances.

Home Equity vs. ROBS

Home equity and a ROBS retirement-based funding structure expose different household assets.

The comparison illustrates why there is no universally low-risk funding option.

Each strategy moves financial risk to a different part of the household balance sheet.

Should You Borrow the Maximum Available?

Not necessarily.

Borrowing capacity tells you what a lender may permit.

It does not determine what amount is financially appropriate.

Consider:

• How much capital the business actually needs
• What personal reserves should remain
• What household debt already exists
• What monthly payment the household can tolerate
• How much home equity should remain untouched
• What happens if the business underperforms

The existence of available credit does not create an obligation to use it.

Preserving Equity Can Have Value

Home equity may also serve other household purposes.

It can represent:

• Long-term wealth
• Retirement resources
• Emergency borrowing capacity
• Future housing flexibility
• Estate value

Using a portion of that equity for business ownership means accepting an opportunity cost.

Those same resources may no longer be available for other household priorities.

What Happens if Home Values Decline?

Home-equity planning often begins with an estimate of property value.

Property values can change.

If home values decline after borrowing:

• The household may have less remaining equity
• Refinancing options may become more limited
• Selling the property may become more complicated
• The borrower still owes the debt according to the loan terms

The funding plan should not depend entirely on continued home appreciation.

What if You Need to Sell the Home?

Borrowing against a residence can affect future housing decisions.

Before using home equity, consider:

• Do we expect to remain in this home?
• Could relocation become necessary?
• How much equity would remain after repayment?
• Would the debt affect our ability to purchase another home?
• What happens if the business and home transition occur at the same time?

These questions can be especially relevant for professionals whose business ownership plans may involve relocation or territory changes.

Stress-Test the Home-Equity Strategy

Before using home-secured capital, ask what happens if the ownership plan does not unfold as expected.

Consider:

• What if revenue takes longer to develop?
• What if interest rates increase?
• What if the business needs additional capital?
• What if owner income is delayed?
• What if another household income source disappears?
• What if the home declines in value?
• What if we need to move?
• What if the business fails?

Then ask:

The Elevare Home Equity Decision Framework

Home Equity and Business Due Diligence

The funding decision should continue to evolve as you learn more about the opportunity.

During business ownership due diligence, new information may change:

• The startup investment
• Working-capital needs
• Owner compensation timing
• Debt-service capacity
• Growth plans
• The amount of home equity you are comfortable exposing

Home-equity financing should therefore not become a fixed commitment before the business itself has been thoroughly evaluated.

Do Not Let Home Equity Define the Business You Buy

Another potential mistake is beginning with:

That reverses the decision process.

A better sequence is:

Funding capacity should help define financial boundaries.

It should not determine which business you pursue simply because the money is available.

Build the Right Advisory Team

Using home equity for business ownership can involve both business and household financial decisions.

Depending on the circumstances, professional input may include:

• Mortgage or home-equity professional
• CPA or tax professional
• Financial professional
• SBA or commercial lender
• Business or franchise attorney
• Insurance professional
• Business ownership advisor

The mortgage professional can explain available borrowing structures.

A CPA can help evaluate tax considerations.

A financial professional may help evaluate broader household implications.

A business lender can explain whether other financing alternatives may be available.

The goal is not simply to determine whether the borrowing can be completed.

It is to understand whether it belongs in the overall ownership plan.

Questions to Ask Before Using Home Equity

• What is the complete capital requirement for the business?
• How much home equity is actually available?
• How much of that equity are we comfortable exposing?
• What type of home-equity product is being considered?
• Is the interest rate fixed or variable?
• How could the payment change?
• How will the payment affect household cash flow?
• How will it affect business cash flow?
• How much working capital will remain?
• How much personal reserve will remain?
• What emergency borrowing capacity will remain?
• What other funding options are available?
• What happens if the business needs additional capital?
• What happens if home values decline?
• What happens if we need to move?
• What happens if the business fails?

Common Home Equity Funding Mistakes

• Assuming all home equity is available to borrow
• Borrowing the maximum simply because it is available
• Focusing only on the initial interest rate
• Ignoring future payment changes
• Treating a HELOC as though it were cash reserves
• Using the same borrowing capacity for several different financial needs
• Failing to protect personal reserves
• Underestimating business working capital
• Ignoring the possibility of declining home values
• Failing to consider future relocation
• Assuming interest will receive a particular tax treatment
• Evaluating the borrowing before fully evaluating the business

Final Thoughts

Home equity can represent a substantial source of household wealth.

In some circumstances, it may also provide access to capital that could be incorporated into a business ownership plan.

But using home equity changes more than the business capitalization.

It changes the household balance sheet.

Additional debt is created.

Monthly obligations may increase.

Housing equity is reduced.

And the residence becomes connected to the performance of a business investment.

That does not mean home equity should never be used.

It means the decision deserves to be made deliberately.

First determine whether the business deserves consideration.

Determine the complete capital requirement.

Protect appropriate business working capital and household reserves.

Compare alternative funding sources.

Understand the loan terms and downside.

Then decide whether exposing home equity is appropriate within the complete ownership plan.

Key Takeaways

• Home equity is the difference between property value and debt secured by the property.
• Available equity and actual borrowing capacity are not the same.
• Common home-equity structures include HELOCs, home equity loans, and cash-out refinancing.
• Home-equity borrowing generally places the residence behind the debt obligation.
• Home equity should be evaluated within the complete business and household capital plan.
• Borrowing capacity does not determine how much someone should borrow.
• Home-equity borrowing is not the same as personal reserves.
• Home equity does not eliminate the need for business working capital.
• Debt service can increase both business and household cash-flow requirements.
• Interest-rate and repayment-term risk should be stress-tested.
• Home values, relocation plans, and remaining household equity should be considered.
• Home equity should be compared with SBA financing, retirement-based funding, cash, and other appropriate capital sources.
• The financing decision should remain part of business ownership due diligence.

Frequently Asked Questions About Using Home Equity to Buy a Business