Should You Use a HELOC to Fund Your Business?

When you’re looking for ways to fund your business, you may be tempted to tap into the equity you’ve built in your home.

A home equity line of credit (HELOC) offers flexible access to cash and can be easier to qualify for than other forms of business financing, especially if you’re just starting out.

But there are some serious downsides to using a HELOC for business purposes. For starters, you could lose your home if you default.

A HELOC allows you to borrow against your home’s equity, which is the difference between your home’s market value and your mortgage balance. Most lenders allow you to borrow up to 85% of your home’s value, minus your mortgage — though total caps vary by lender.

For example, if your home is worth $500,000 and you owe $200,000, you may be able to access up to $225,000.

A HELOC works sort of like a credit card: once approved, you can borrow as needed up to your limit. As you repay, those funds become available again throughout the “draw period,” which typically lasts 10 years. After that comes the “repayment period,” where borrowing ends and you pay back what you owe (up to 20 years).

Most HELOCs have variable interest rates that often start lower than rates on traditional small-business loans.

To qualify, you’ll generally need a credit score of at least 640, a minimum of 15% home equity and a low debt-to-income ratio.

Yes. Because HELOCs don’t restrict how you use the funds, you can legally use one to cover startup costs. This is one of the workarounds for new entrepreneurs who don’t yet meet all of the requirements for traditional business loans.

But just because you can use a HELOC to bootstrap your business doesn’t mean you should.

Because your home is on the line, you want to think of using a HELOC as a last-resort option.

That said, there are specific scenarios where tapping into your home equity could make sense, provided you understand the risks and have a solid plan in place:

Many traditional small-business loans require two or more years in business and steady revenue. If you’re in the early stages of launching your company, you likely won’t meet that bar. Because a HELOC is based primarily on your personal finances (specifically your home equity and credit score), it doesn’t require any business history.

The best way to use a HELOC for business is to cover short-term cash flow gaps, like a seasonal dip, or high-impact investments, like equipment, software or inventory, that you’re confident will boost revenue. Ideally, you should be able to recoup the money quickly, minimizing both interest costs and the risk of falling behind on payments.

Roughly half of small businesses close within their first five years, according to the latest data from the U.S. Bureau of Labor Statistics^[0]

Your backup plan might include a working spouse with reliable income, a sizable cash cushion or liquid assets or investments you can tap if needed.

A HELOC can offer greater flexibility than many traditional business loans when it comes to paying it back. You may be able to stretch payments over 20 to 30 years, and during the first 10 years, you may only be required to make interest-only payments.

This repayment structure can significantly lower monthly payments on borrowed cash compared with traditional business loans, which often require full repayment within five to 10 years (or sooner). Just keep in mind: The longer you take to repay the balance, the more you’ll pay in total interest over the life of the loan.

Using collateral is one way to secure a business loan with lower interest rates and better terms. And many business loans require it. But if you’re just starting out or running a lean operation, you likely won’t have much in the way of business assets.

In that case, a HELOC can help secure funding with favorable terms and rates since lenders have the safety net of your home to fall back on in case you don’t make payments.

• Potential option for startups. Approval is based largely on your personal credit and home equity, not your business’s age or revenue.

• Generous repayment terms. Many HELOCs offer interest-only payments during a draw period that can last 10 years, followed by a 10- to 20-year repayment period. Payments are also made monthly.

• Flexible access to funds. You can borrow only what you need, when you need it, and pay interest on only what you borrow.

• Lower interest rates. HELOCs often have lower rates than small-business loans.

• Risk of foreclosure. Because your home serves as collateral, defaulting on the loan could cost you your house.

• Variable rates. Interest rates can rise over time, increasing your monthly payment.

• Reduces home equity. Borrowing against your home decreases the equity you’ve built. This can put you at risk of being underwater on your home if its value drops. It can also mean less cash available for a down payment on a new home if you wish to move in the future.

• Doesn’t build business credit. Since a HELOC is tied to your personal finances, it won’t strengthen your business credit profile. It can, however, help build (or hurt) your personal credit score.