I not only grew up in a family business and watched my Dad dip into the equity in our home when he was short on cash, there was a time or two when I felt compelled to fund my business with home equity. It’s not something I recommend today. Let me tell you why.
As a Small Business Owner, You Probably Understand
I hope you find this disclosure of my past mistakes helpful as you face the current health and economic crisis.
I’ve spent the last 40 or so years working in small businesses and have even had my hand at the tiller leading one a time or two. I’ve been responsible for making sure employees got paid, vendors got paid, other day-to-day financial obligations got met—and hopefully there was something left over so that I got paid (which didn’t always happen).
Many small business owners are a lot like I was. They take the success of their small business personally and take responsibility for the financial well-being of the people who work for them.
Is Using Home Equity, or Other Personal Credit, To Fund Business Activities a Good Idea?
My short answer is, “No.” And even though it’s complicated “No” is still my answer.
In uncertain times like what we are experiencing now (caused by the current coronavirus health crisis), I have found myself giving some advice to deal with the financial crisis that I might not otherwise give. For example, if you have a line of credit, you might want to make a draw now to set aside some cash just in case you need it should your revenues take a big hit as businesses like restaurants, small merchants, and others are compelled to temporarily shut their doors.
I give that advice today because I witnessed lenders who closed credit lines and called due balances that actually hurt many otherwise healthy small businesses in the aftermath of the financial crisis of 2008. Businesses that would have successfully and profitably weathered the storm had they been able to maintain access to the capital they needed for business operations. Like many small businesses around at that time, it took a few years for banks and other traditional lenders to start approving loans to small businesses again—making it possible for online lenders, and folks like us here at Nav, to make more capital available to more small businesses than ever before.
With that said, I still can’t recommend using home equity to fund a cash-strapped business—especially in the middle of a crisis like this one.
But I Have Lots of Home Equity and I Need the Cash
I’ve told myself the same thing. More than once.
I had plenty of equity, I had a good enough credit profile that it was easy to qualify for the credit line, I needed the cash, and the bank wouldn’t approve a loan to my business (there weren’t as many business loan options available then as there are now).
I convinced myself that home values had nowhere to go but up; so filled with small business owner-hopium, signed on the dotted line.
I was able to meet what I thought was a short-term need with a lot of negative long-term consequences. Consequences that were costly enough that I would never even consider it again. Particularly when I found out the hard way that it wasn’t really a short-term need and that I would need to dip into the well more than once.
The Potential Long-Term Consequences of Leveraging Home Equity as Business Financing
I recognize that I am pretty conservative about financing generally and understand that this is an option that has been successfully used by many willing to face the potential consequences, but here are some of the long-term challenges I’ve had to wade through by using this short-term approach to capitalize a struggling business.
- I added additional monthly burden to my personal finances. Over a few years, I basically doubled the debt burden associated with my home—as well as doubling my monthly payment obligation. It didn’t make it easier to get by, it made it much harder.
- It basically added an additional 10 years to my mortgage. I mentioned that I had done this a couple of times. In real terms, I added a lot of amortizing interest that I am still paying to this day. Had I not taken this approach, my home would be paid for now. That might not be a concern to a lot of people, but it would be my preference.
- My personal credit profile plummeted. Because I paid myself last (a problem for a different conversation), I often found myself paying my now-doubled mortgage late, causing my credit score to drop, making it even harder to access borrowed capital, ultimately causing me to dig an even deeper hole for myself taking many years of concerted effort to dig out of.
- I was a whisker away from losing my house. Being late on mortgage payments will decimate your personal credit score. Two or three months of that will potentially cause you to go into foreclosure. Fortunately, I was able to pull a rabbit out of a hat and keep my home, but it wasn’t easy and it was very, very stressful.
- It didn’t help me build a strong business credit profile. Because it was personal debt, my personal credit score was flailing and making it impossible to build a strong business credit profile.
- It didn’t save my business. Nobody likes to admit failure, but I became one of those failed-business statistics. I was undercapitalized and as my customers struggled in a changing economy and were circling the abyss, my business was following right behind them. I eventually had to let my employees go and close down my business too.
It Was an Expensive Lesson That Helps Inform How I Approach Business Financing Today
One of the biggest lessons I learned from this experience is that it’s not more money that makes a business successful, it’s creative problem solving. Of course that might not be the case for many businesses in the midst of the current financial crisis, but it will help you address those challenges that might not require capital to solve.
For Cash-Strapped Businesses There are Still Options
The SBA, in an effort to make capital available to businesses impacted by the current coronavirus crisis have made applying for the Economic Injury Disaster Relief easier and faster. Because it will likely take a few weeks for this relief to kick in, I suggest you start the process sooner rather than later.
In the meantime, here are some options to bridge the gap that I would recommend over leveraging your home equity.
0% APR Business Credit Cards
If you need access to capital quickly, a business credit card can be a good option. Especially given the recent cuts to the Prime Rate by the Federal Reserve, which means credit card APRs will likely lower in the next few weeks. American Express®, Discover®, Capital One®, and Bank of America® all offer 0% APR business credit cards that could help your business access needed capital to meet budget shortfalls during the health crisis.
A Business Line of Credit
A business line of credit is a time-tested way for a small business to have quick access to cash to meet an unanticipated need. The upside of a line of credit is that you pay for what you borrow, but know the full line is available if you need it — a good option for business owners who haven’t been hit yet, but want to be prepared nonetheless.
A Business Term Loan
The short applications and quick decision-making make it easier than ever for a small business to apply for an online term loan. An application can often be completed in a matter of minutes with an answer in 24 hours or less. What’s more, funds can be electronically deposited in your account within days.
A Nav’s “Legitify Your Small Business” Grant
We’re offering a $10,000 small business grant to the most deserving business that applies. The application is easy, we just ask that you let your personality shine. Good for: existing businesses.
Feel free to reach out to one of our credit and lending specialists today and we will gladly answer questions and help you find the right solution to help you weather the storm.
Please keep in mind this information is changing rapidly and is based on our current understanding of the programs. It can and likely will change. Although we will be monitoring and updating this as new information becomes available, please do not rely solely on this for your financial decisions. We encourage you to consult with your lawyers, CPAs and Financial Advisors. To review your real-time funding options with one of Nav’s lending experts, please contact us.
This article was originally written on March 19, 2020 and updated on October 5, 2021.