Home Equity Loans & Creative Small Business Financing
You don’t have to have investors or a traditional business development bank loan to start your own small business. If you own a home or have the credit to open revolving credit card accounts, your small business financing could be a reality.
The secret to using credit cards for small business financing is to open the credit cards under the business name. If you have business credit cards, the IRS allows the deduction of every single penny of interest from those credit cards.
David Newton is a professor of entrepreneurial finance at Westmont College in Santa Barbara, California. He says there are basically two ways to use credit cards to finance a small business: 1. Asset acquisition such as purchasing equipment and supplies, and 2. Cash on hand as capital. He does; however, consider credit cards as an extremely risky way to finance a small business
“The use of credit cards should be replaced as soon as possible by more traditional bank financing and/or leasing arrangements, once the firm has reached the break-even point and monthly sales receipts can cover normal COGS (cost of goods sold) and overhead expenses.”
A more traditional approach is the home equity loan. Banks usually offer home equity loans for 125% of the property’s fair market value or FMV. For example, if your home is valued at $300,000, and your mortgage balance is only $100,000, there’s already $200,000 of equity. The bank would loan you the amount of the equity plus an extra 25% or in the previous example, $75,000. You would then have $275,000 to start your small business.
But, the credit card route allows deduction of all the interest, while the IRS limits the amount of the home equity loan for purposes of deduction. IRS publications 936 limits the amount eligible for the interest deduction to $100,000 or the actual value of the home minus the mortgage balance, whichever is less.
Entrepreneur.com shows there are down-sides to home equity small business loans. “You may be asked to pay up-front fees, closing costs, or annual fees. Some home equity loans also require large balloon payments at the end of the loan, while others require higher monthly payments instead. If you choose a loan with a large balloon payment, be sure you know how you will cover the expense. In some cases you may have to borrow more money to make the balloon payment. “
The biggest risk using your home as collateral is the potential loss of your home is the business fails or the loan defaults.