Should I Use Home Equity to Start My Business?

So you’re ready to take your small business to the next level. Maybe the app you’ve spent a decade developing is attracting big interest from tech talent, and ready for takeoff –– or those luxury candles you started making in your kitchen are selling like hotcakes and you’re ready to expand. But how can you fund the growth your business needs? Starting a business requires a substantial nest egg, and you’ll need capital to get the ball rolling and start generating income. A home equity loan is one of many ways for Canadian entrepreneurs to generate the financial launchpad they need. 

What is a home equity loan?

Home equity is the difference between the current value of the home you own, and the mortgage you still owe on it. You can calculate your home equity by starting with the current market value for your home, and subtracting the mortgage balance you owe from that. If you’ve already paid off your mortgage (congratulations are in order!) then your home equity is roughly the market value of your home. Home equity can rise or fall as the market value of your home changes. A home equity loan  –– or second mortgage –– borrows against this equity.

Pros and cons of using a home equity loan to start a business

Is it wise to use your home equity to help finance your business? It depends on your situation. 

Here are the benefits of funding a business with home equity:

• Home equity loans typically have lower interest rates than other types of loans, and you’ll only pay back interest on the amount you borrowed. 
• The repayment terms of a home equity loan are typically longer, so you’ll pay a smaller amount each month than you would with most other loan types.
• You’ll only need to apply once to qualify, and getting a home equity loan for a large amount may be easier than qualifying for a small business loan.
• Refinancing your home may let you borrow up to 80% of your home’s appraised value, and you may also qualify for a Home Equity Line of Credit (HELOC). 
• Contrary to typical business loans, you don’t need to prove your business is profitable to qualify, or present a business plan as part of your application.

Cons of using a home equity loan to start a business

Using your home equity loan to start a business might not be the right choice for you. There can be serious implications and you should be cautious and talk to your advisor about all your potential risks.

Here are the drawbacks of funding a business with home equity:

• Not everyone will be approved for a home equity loan, and you’ll need to go through an approval process to see if you qualify. 
• To qualify for a home equity loan, you’ll need a high credit score, a reasonable or low balance of debt, and proof of high and consistent income. If you’ve changed jobs or accumulated debt since buying your home, this could impact your viability.
• A second mortgage carries weight; if you default on your loan, you could lose your home. In the event that this happens, your mortgage lender is paid off first. 

How to use a home equity loan to start a business

If you’re ready to move ahead, here’s how you can use a home equity loan to get your business off the ground.

1. See if you’re eligible for a home equity loan

Let’s not put the cart before the horse. Start by finding out if this kind of loan is an option for you first. A potential lender will look at your credit score and your loan-to-value ratio (LTV) to establish what kind of loan you’re eligible for. Just because you’re eligible for a big loan, doesn’t mean you should borrow the maximum amount. Talk to a specialist about the best decision for you and your financial future.

What is loan-to-value ratio (LTV)? 

Each lender (bank, private lender, or financial institution)  has an LTV, which is a maximum percentage for what you can borrow against your home. An LTV of 90 per cent means that your total home-related debt (your mortgage + your pending home equity loan) can’t exceed 90 per cent of your home’s value. So if your home is worth 1,000,000,  and your mortgage is $500,000, the maximum amount the lender could offer you is $400,000. 

2. Choose the right lender

You shop around when choosing almost anything else; a pair of shoes, the right car, or a vacation spot. So don’t settle for the first option when considering a home equity loan. Be assertive and ask good questions so lenders know that they need to prove why they deserve your business:

• What is the interest rate, and how does it compare to other rates? If it isn’t the lowest, why should you choose this lender? Ask them to clarify the advantages they’re offering.
• What are the upfront costs, administrative fees or closing costs for this loan? Each lender varies and fees can add up.
• Check with your bank about home equity loans they offer. Most banks offer incentives, packages, and bonus offers for loyal clients.

3. Make a smart debt repayment plan

Monthly repayment amounts for home equity loans are typically lower than they are for other types of loans, which takes off the pressure. With most home equity loans, you’ll get a monthly check like you do for your electricity bill or your Netflix account. 

Ask your financial advisor to help map out how your loan repayment aligns with life’s surprises and future plans. How long will it take to conceivably pay off the money you’re borrowing? What other surprise costs do you anticipate? If you have kids starting college or plan to buy a second home, it’s especially important to build a strong plan. 

Other loan options for Canadian businesses

Consider all of your options before you decide to go with a home equity loan. Another option might suit your situation or plans for expansion better. Use online tools to help calculate interest rates and repayment periods for various loan options. 

• Business equity loan: If you have an established business, you may want to consider a business equity loan. This operates in a similar way to home equity loan, but it doesn’t’ put your home up as collateral; your business acts as the collateral instead if you default on your loan.
• Programs for specific demographics: research grants that are specific to your. Look for programs and resources that are especially for young entrepreneurs, Indigenous-owned businesses, women, Black entrepreneurs, or LGBTQ2S+ business initiatives to maximize all the opportunities available to you.
• Smaller operating and short-term loans: If you’re looking for a bit of added security when money gets tight, consider a credit line or apply for bigger overdraft protection within your accounts to make sure checks don’t bounce.
• Asset-based lending: Some banks may offer advances, loans, or refinancing options for fast-growing businesses with working capital. This is typically more suited to more mature businesses, but could be relevant to some successful startups.
• Grants and awards: Canadian businesses can apply for a plethora of small business grants that offer cash for your business, tax credits, mentoring opportunities, and industry-specific awards. Try using the government’s business benefits finder to seek out opportunities for you.

Home equity loans vs small business loans 

A business loan is another type of loan you can use to access a nest egg for your business.

While a home equity loan assesses your financial assets and resources, a business loan relies more heavily on your business plan –– including projections and long-term business plans that prove potential profitability. The maturity, profit, and other aspects of your business might make either option right for you. 

Home equity loan	Small business loan
Assesses your financial assets and resources including your income, financial standing (credit score and debts), and your home’s market value vs. mortgage owing.	Assesses your business plan, long-term projections, and the viability in your business in addition to your financial standing (credit score, income, debts, etc.).
Typically a lower interest rate	Typically a higher interest rate than a home equity loan.
Only your financial standing and home equity affect the loan amount, not your business plan.	Some banks require minimum revenue for a business to be considered for a loan. They may also require you to have been in business for a set amount of time.
A home equity loan typically has less restrictions and does not designate what you have to use the money for.	Has restrictions on what you can use the money for.
Your home acts as the collateral. But if you default, you may lose your home.	May require collateral in case you default on your loan, which can be hard for a new business to secure.

Ready to start your business? Here is what you need

It’s great to have a big idea and the passion you need to get it going. But a successful rocket launch needs a bulletproof plan, manual, team, and funding to make it work. Even if it isn’t necessary for a home equity loan, a strong foundation and some thoughtful planning can help you launch a successful business, and can unlock the door to the future funding you need.

Build a template for your business.

Before you start looking at funding options, start with a brainstorm and a strong business plan. Establish the core focus of your business, plans for future expansion, your target demographic, the size and scope of your work, and potential competitors or similar businesses in your market. Look for mentors in your field to help develop your plan.

Become an expert in your field.

Learn everything you possibly can about the market and industry you’re in. If your business makes specialty hiking boots, get to know the outdoor market and sign up for newsletters that keep you updated on marketing trends. Are you planning to sell your boots across Canada? Research local climates and learn about what a customer in Montreal might be looking for in a boot compared to your Halifax market. Who will buy your shoes? Get inside the head of your target demographic and learn about who your customers are. 

Get your finances in order and plan to invest.

Investors like to see that you’ve put your own money into your business. Lenders will also want to see a great credit score, so make sure you’re paying off debts and improving your financial wellness to improve your candidacy for future loans. A great financial plan lets you invest wisely.

Use online resources

Whether you’re applying for a loan, opening a business account, or registering your business, use an online resource like Ownr to streamline the process, and get set with everything you need to start your business.

• Open a business bank account to keep work-related costs in one place.
• Get to know the facts on incorporating your business. Each province has different regulations, and it might make more sense to incorporate federally instead of provincially, depending on the scope of your business.
• Begin anticipating small business and start-up costs so you’re well prepared for any situation.

Get support for your home and your business with online tools

Check out the GarbageDay app for more tips for homeowners, and get help from our friends at Ownr when you’re ready to make your business idea a reality. From home equity loans to building your business, it’s all just a click away.