When starting a new business, an entrepreneur's first instinct is to turn to a bank for a business loan. Most banks prefer to lend only to established businesses, however, creating a catch 22. Home equity loans provide an excellent alternative.

The home is the embodiment of the American Dream. For many entrepreneurs, it also helps fuel another dream-their own businesses. Small companies often use home equity loans as capital for the early stages of their development. Their preference is usually the home equity line of credit (HELOC), which works like a credit card, has relatively low interest payments, and offers tax benefits.

Advantages of a HELOC

The HELOC holds plenty of benefits for a small business. First, the funds are easy to access. If a homeowner has equity in her home, she can secure a line of credit at an interest rate based on the prime rate. Rates increase once you bypass the 80 percent loan-to-value ratio, so you'll want to keep your loan size below that level.

With a HELOC, you only pay interest on the amount of money you actually use. Similar to a credit card, it allows you to carry a large line of credit, and access it whenever you'd like.

The interest you pay on a HELOC is tax-deductible, and there should be no closing costs or usage fees. You may have to pay for an appraisal of your property; but generally speaking, there are no other costs.

A word of caution

The HELOC has plenty of flexibility; but be careful how you use the funds. While the loan's interest rate generally hovers in the single-digit range, these costs can add up as the loan gets larger. There's also the possibility that the variable interest rate could increase at any time.

Since this is a loan secured on your property, you could potentially lose your home if you fail to make the payment. Always consider this possibility when you start tapping more and more equity.

A short-term fix

The best use of a HELOC is to consider it as a short-term method of financing. Use it to obtain property, or a piece of a business. When your business is underway and doing well, use the assets of your company as collateral to obtain a business loan. You'll then eliminate the risk of losing your personal palace should you go into default on the loan. The business loan generally comes at a better interest rate, and can be used to pay off the HELOC.

Making the American Dream come true takes a lot of discipline and hard work. Opening your own business is no different. A HELOC can provide you with the springboard that you need to open your business and eventually qualify for a traditional business loan. It's why, for countless entrepreneurs, using the equity of their homes to start a company has worked like a dream.

Published on October 27, 2007