NFIB

Home Equity Loans -- A Viable Way to Finance Your Business, Part I
04/ 11/ 2002

If you've owned your home and have been paying on your mortgage for several years, there's a good chance you've built up equity, especially if the value of your house has appreciated since the time you bought it or built it. Equity is defined as the difference between the appraised value of the property and the amount of the mortgage.

For instance, if your house is appraised at $100,000, and you have $50,000 left to pay on your mortgage, you have $50,000 equity. The amount of equity that you have can be used as collateral for a "home-equity loan" from a bank. The loan that you receive can be used for any purpose: improvements on your house and property, a vacation, or help in financing your business. In today's and next week's Workshops, Jeffrey Moses discusses some basics of home-equity loans and offers a few tips on how to make the best use of the loan you receive.

A home-equity loan is, by definition, a mortgage. If you already have a first mortgage on your home, when you approach a bank for a home-equity loan, you will in effect be asking for a second mortgage. Very few states today allow third mortgages, so if you already have both a first and second mortgage, it's unlikely that you'll be able to receive a home-equity loan, even if you have ample equity limits available.

Because home-equity loans are "secured" loans based on the collateral of a person's home equity, such loans are much easier to get than "unsecured" loans. And you'll pay a lower rate of interest on a home-equity loan than you would on an unsecured business loan. In addition, home-equity loans can be paid off over a longer period than normal business loans. These advantages make home-equity loans extremely attractive to small-business owners needing financing.

Now, on to some specifics. When a customer applies for a home-equity loan, a bank will review the customer's credit rating. This will determine both the availability and the interest rate on the loan. The better the rating, the easier it is to receive a loan and the lower the interest rate will be. When filling out the loan application, you should clearly indicate that the loan will be used for business purposes. You won't need the usual information for requesting a business loan (tax returns, financial statements, etc.) because the loan will be made based on the equity in your home as collateral.

The bank will then request an appraisal of the property, using either the bank's appraiser or a licensed appraiser named by the customer. The cost of appraising is usually between $250-$350, and is paid by the customer. Based on this appraisal, the available equity in the property can be calculated using the above-mentioned formula: Appraised value less the amount of mortgage equals the available equity.

How much can you borrow against this equity? That depends on the type of property you own. For condos, many banks set a loan/value ratio of about 75%, meaning that condo owners can normally borrow up to 75% of their available equity. Home owners can sometimes borrow up to 100%, depending on their credit rating and whether they are established customers of the bank. Normally, however, homeowners can expect to receive a loan/value ratio of about 95%. Some mobile home owners can receive up to 85% of their equity, although some banks don't offer second mortgages on some types of mobile homes. Within these parameters are numerous variables, with each case being unique.

Next week's Workshop continues this discussion, listing specific costs of home-equity loans and showing preferred ways for receiving the loan amount.

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