Can a HELOC, Home Equity Line of Credit, Be Used for a Business
It might be for a new business startup or to get working capital for an existing business, but using a HELOC (home equity line of credit) has traditionally been a key financing tool for many small business owners. Over the years the rules to qualify for a home equity loan have changed and so has the tax write-offs. I have built 6 companies over the last 25 years and I have had my share of HELOC’s (home equity financing) that I used to help my businesses. Let me share with you the advantages, disadvantages, and what traditional banks will look for to approve your application.
How a HELOC Works(home equity loan)
A HELOC is a personal line of credit using the equity in your home as collateral. The equity in your home can be calculated based on the market value of your home minus the mortgage loan still owed to the bank.
A Line of credit is a preapproved fixed amount of money that you will have access to for any reason. You can draw on those funds whenever you like and pay the line back whenever you want. When you do draw on your line you will be required to make a monthly payment based on the daily outstanding average balance. The interest payment is often based on the defined prime rate also known as the interest rate at a specified period of time as described in your closing documents.
Whereas your home regular mortgage might have a fixed interest rate (APR- annual percentage rate)for the length of its term, a HELOC will have a varying interest rate based often on the prime rate. In general, a mortgage might have a much lower interest rate (APR) but keep in mind that a HELOC is designed to be used for the short-term whereas a mortgage is spread out over a 15-30 year period and has a much larger loan amount.
Can a HELOC Be Used For a Business
Yes, a home equity line of credit can be used for any purpose you like including to remodel a primary home, paying for college tuition, or starting/improving a business. Once approved, the bank will not ask you what the funds are being used for.
However, if you are applying for a HELOC, it might be best to not share with your banker that you are using the funds to help your business if that is the case. It may not matter as long as you have the equity in your home (or any other real estate) to back up the credit line however once you reveal that you are using the HELOC for your business, bankers, and underwriters will ask for more documents pertaining to your business. If the bank sees problems in your business they might deny your home equity loan application.
If a banker asks what the funds will be used for when you apply for a home equity line of credit let the banker know there are no plans to use the HELOC at this time but that you just want to feel secure in knowing that you have an emergency cash backup plan, just in case it is needed.
How Long Is a HELOC Approved for
In many cases, a HELOC will be approved for 5 to 10 years meaning that you will not have to reapply yearly. That is one of the reasons a HELOC is such a powerful business financing tool. If your business applied for a business line of credit instead of a HELOC, you would find that the bank would only approve your business line of credit for 12 months with annual reviews needed each year.
Getting a business line of credit approved is completely different than being approved for a HELOC. In the first place a revolving line of credit is really hard to be approved for. A business line of credit takes a ton of time, energy, and documents. The reason why a revolving line of credit is so much harder to be approved for is that if you default on a small business loan it typically means that your business will declare bankruptcy and because of that bankruptcy, the bank will not be able to recoup the outstanding loan balances that you might owe.
If you default on a HELOC there is still equity in your home and your bank can take your home to pay off the balance that is owed on the HELOC and first mortgage.
Credit Reports, HELOC’s, and Business Credit Lines
Whenever you apply for a HELOC, personal loan, credit card, small business loan or a revolving line of credit one of the first criteria that a traditional bank will look at is your credit score. In general, a personal credit score above 650 is considered to be good. Anything about 700 is considered excellent. Traditional banks are going to want to see a personal credit score above 680 to approve you for a HELOC, personal loan, or business loan, and the higher your score, the higher the credit limit on your HELOC or business credit line will be.
What is The 1st or 2nd position When It Comes To HELOC
When you get a mortgage loan, HELOC, or a small business loan the lender providing the financing will file what is called a Uniform Commercial Code (UCC). A UCC is a legal filing that informs all other lenders that they have a position in the equity of your home, business assets, etc. An example would be the bank that you have your home’s first mortgage with would be in the first position. That means that if you default then that bank has 1st rights to the equity of your home when auctioned or sold. If you decide to get your HELOC with another bank then that bank might be in the second position and in general, banks do not like to be in the second position. If they are in the second position, they may not approve you for the same amount of money then if they were in the first position.
In general, banks that are willing to approve you for a HELOC will be the same bank that approved you for your mortgage. It is also why a lot of people get a HELOC in place when they are refinancing. Banks will often approach you with the idea of getting a HELOC when you are refinancing your mortgage.
Does a Recession Have an Effect on HELOC Approvals
Yes, a recession can have a major effect on new HELOC approvals because traditional banks are extremely conservative and when a recession hits, the underwriters at banks are often told to greatly reduce the exposure the bank has to new financing. A recession doesn’t mean that you will not be approved for a HELOC but it could also mean that the requirements the bank is looking for will be much stricter or that the approval amount might be a lot less then what you wanted.
In my experience, about 95% of people apply for a business line of credit or a HELOC when they need it and that is the worst time to apply. A good business owner gets their line of credit set up when they don’t need it because if one runs into a cash crunch emergency, you will need to have the time to be approved for the credit line in time.
Getting Approved for a Business Line of Credit vs A HELOC
Applying and being approved for a business line of credit is a completely different process than for a Home equity loan or HELOC. A business line of credit will require that an extensive application be filled out and the creditworthiness of your business will be evaluated. A traditional bank will want to see some form of collateral to back up the business credit line and that collateral could be business assets, business receivables, and even property that the business owner owns including your home.
In the case of using your home as collateral for a business loan, your business bank will file a UCC (Uniform Commercial Code) against your home notifying other lenders that they have a position on your home in case of default. If the bank your business is applying to is not the same the bank you have a mortgage with then the bank your business will be dealing with will be in a second position. In most cases, this will not be a problem and in fact, most homeowners and business owners are unaware that UCC’s are even filed until you go to make a change on your mortgage.
In regards to business lines of credit or business loans, you may be able to negotiate with your bank to see if they are willing to avoid using your home as collateral. If your business has a strong balance sheet and financials, if you have an excellent credit score and if you are a long term customer of the bank already, the bank might be willing skip using your home as collateral. But it will not be easy. The bank is going to really push back on you to require that you include the equity in your home as collateral.
When banks look at approving you for a business line of credit they will be looking at many parts of your business. What industry are you in, what’s your total revenue, what’s your gross and net profit margins, what type of clients have you had, how long does it take for you to collect your accounts receivable, how do you finance your business now, and what is your capital/debt value ratio. There are so many measurements that banks will look at that being approved will takes a lot of time.
The Affect The TRUMP Tax Plan Has On HELOC Tax Deduction
In the past, the interest paid on the use of a HELOC could be written off on your tax return 100% regardless if the use of the HELOC was to improve a home, pay for college, or be used to start a business. However, after the TRUMP Tax Plan in 2018 the IRS tax deductions on the annual fees and interest of a HELOC can no longer be written off if used for business. The HELOC’s use must only be used for the improvement of a 1st home to have a tax deduction and there is a lot of fine print to consider. According to the IRS, the amount you can deduct is only up to $100,000 and that also depends on the value of your home. For example, let’s say you bought a real fixer-upper for $75,000. You would only be able to deduct the interest paid up to $75,000 if using a HELOC.
If you are looking to see if your HELOC is tax-deductible, it would be a good idea to check with your tax advisor before you move forward. You might find that a business line of credit would be more advantageous.
Costs associated with a HELOC vs a Business Line of Credit
There are two things that make a HELOC more attractive then a business line of credit and that often comes down to time and costs.
The amount it usually takes to apply for a HELOC and to be approved is a fraction of the time it will take for a business loan to be approved. However, keep in mind that many business owners often will have both a business line of credit and a HELOC. Although I may not use both my HELOC and my business line of credit I always make sure I have both in place because I have been in situations in the past where I needed extra capital. It is always a good idea to have all your financing options ready to go in case of an emergency or opportunity.
When it comes to the costs, a HELOC will be a lot cheaper than a business line of credit. A HELOC will have a small upfront origination fee whereas a business line of credit will have closing costs, application fees, and yearly maintenance fees.
In regards to a business line of credit the bank might require a certain draw period indicting that they will want you to use your credit line and the bank might also specify a cleanup period where the bank will want you to have your balance down to zero for a 30 day period.
The other key difference in regards to a HELOC and a business line of credit will be the approval amount. In general, if your business requires more then a $100,000 credit line a HELOC might be harder to be approved for. A HELOC’s credit limit is approved based on the equity in your home whereas the credit limit on your business line of credit will be based on your business financials.
Why Financing Solutions Business Line of Credit is Valuable
Financing Solutions, an A+ and 5 star rated BBB company is a direct lender that provides unsecured lines of credit to businesses and nonprofits. Because Financing Solutions is not funded from bank deposits nor the government, Financing Solutions can provide business lines of credit easier, faster, and many times, less expensive.
Financing Solutions business line of credit requires no collateral and no personal guarantees because we are evaluating your business’s ability to pay back your line of credit based on your past cash flow. A traditional bank can’t make mistakes because they are regulated by the government. Financing Solutions money is provided bu investors and as such, we do not have to follow the old school lending approval process.
If your business is less then $5 million in yearly revenue over the last 10 years, the chances of you working with a non-traditional bank for a business line of credit is almost 90%. That is because many business owners don’t have the time to deal with a long bank application process and also may not have the collateral/credit score to qualify.
Financing Solution’s line of credit product costs nothing to set up and nothing until used making it a great cash back up plan for emergencies and opportunities. The product is different than the working capital loans, HELOC, or bank lines of credit offered by traditional banks because many businesses do not use their credit line very often. A small business owner often only uses a credit line when there is a delay in a client payment or when an emergency came up that requires extra funds.