Small businesses are the backbone of the U.S. economy. According to the October 2010 "Facts and Trends," which is published by the Federal Reserve Bank of New York, a small business is a privately-owned company that has fewer than 500 employees, and sales lower than $25 million annually. They "employ nearly half of all Americans, account for about 60 percent of gross job creation, and historically have created more jobs than larger firms at the start of economic recoveries." That's why small businesses are crucial to economic salvation.
Unfortunately, these companies are not getting the financial help they need from banks to survive. The study reveals that more than half of the 59 percent of business owners who applied for credit were turned down, and 75 percent received none or only some. If your firm needs money and you have equity in your home, your last resort may be to tap your home equity to finance your business needs.
Turning home equity into cash
There are three ways to pull money out of your home - with a home equity loan (HEL), home equity line of credit (HELOC), or a mortgage refinance.
With both a HELOC and a HEL, the application process is quicker than with a mortgage refinance, and much less expensive. If you have outstanding credit, you may be able to find a lender who will waive them completely. But that's where the similarities end.
With a traditional home equity loan, your rate will be fixed, and you'll have a set time in which to pay it back, with regular, unchanging monthly payments. A HEL is good if you know exactly how much money you'll need, and want the security of knowing exactly what you'll pay each month.
If you want more flexibility, a HELOC may be the financial instrument of choice. The bank will extend a credit line, and you can draw against it as needed, much like a credit card. During the draw period, you may only be required to pay back interest and a small amount of principal. But be careful if you only make interest payments. At the end of the draw period, the entire outstanding principal may become due, and you may be forced to refinance or take out another home equity loan.
The other option is a cash-out refinance. If your home has equity, you can refinance for a mortgage amount above your principal balance, and use that additional cash to fund your business needs. The advantage of a refinance over a home equity loan is that your interest rate will generally be lower, and you'll have up to 30 years to pay it off. The disadvantage is that closing costs can be high - up to 3 to 6 percent of the mortgage amount.
Banks may be denying small business owners access to funds, but that's not going to stop these entrepreneurs. Where there's a will there's a way. And where there's accumulated home equity, there's a way to tap it. By freeing up cash in their homes, small business owners can lead the way to a brighter economy.