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Remortgaging your house is a tried-and-tested method of securing funds in the short term in order to start a business. Ray Kroc from McDonalds, along with many Dragon’s Den contestants, acts as a poster child for using home equity to fund your projects.
However, there are many factors to consider before deciding if this is the right course of action for you and your business.
How Does Home Equity Work?
As a homeowner, one of the key advantages is having equity. This equity allows you to purchase a business through the process of remortgaging.
There are home equity loans and home equity lines of credit (HELOCs).
A home equity loan has a fixed interest rate and a fixed repayment schedule. It works like a normal mortgage in that it is a one-off lump sum payment which is repaid monthly. They typically have high payments as you are repaying the principal loan as well as interest each month.
HELOCs, on the other hand, function like a credit card. They have a variable interest rate, rather than fixed, and you can use the equity as and when you need it, up until a pre-agreed limit. With these, you can also borrow them for a certain period of time meaning that you repay interest only when you withdraw the funds, at a rate that may vary over time.
Key Factors to Consider
When looking to use your home equity as effectively as possible, you need to assess the wider economy. This strategy is most effective when there are stable interest rates and when home prices are on the rise.
If you are considering a home equity strategy, you should always speak to a professional financial advisor before you do anything.
- Cost: Firstly, you need to ensure that the investment is cost-effective. This means that the investment will have a greater after-tax return than the initial cost of the loan.
- Property location: You need to assess how your neighborhood is appreciating or depreciating, in value.
- Taxes: Interest on home equity loans is typically not tax-deductible so this will be another cost to keep in mind.
- Liquidity: Should you face an urgent expense, would you have enough cash flow in order to cover costs?
- Debt: Do you have any other significant debt such as credit cards or car financing? This could affect the interest rates
All of these factors require thorough exploration and expert opinion before any decisions are made.
Advantages of Home Equity Financing for Business Purposes
Home equity loans typically carry lower interest rates than personal loans meaning that your total repayment is lower. The average home equity loan has an interest rate of between 6% – 10%. Small business loans, on the other hand, can range from anything from 7% to as high as 30%.
Another advantage of home equity loans is that they have little to no limitations. Small business loans often come with specific restrictions which allow for less flexibility.
Remortgaging your home can be a great option for those businesses that are fully self-funded as it allows them access to money without the need for any company history nor external investment.
Disadvantages of Home Equity as a Method of Financing a Business
When adding your home as collateral, it adds a greater element of risk to the already high-risk process of launching a new business. If you take out a loan and your business fails, you have not lost anything in the process. However, if your business fails and you have used your home equity to finance the project, you could well lose your home.
The home equity method can give rise to many hidden fees which may turn out to be more expensive than they appear at first glance. These can include fees such as when you are penalized for early repayment. In order to make a fully informed decision, you should research all the fees and their sum cost before deciding if it makes sense.
Photo by Kindel Media from Pexels
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