A home equity loan and line of credit are both good options to fund your business, but a home equity loan (HEL or HELOAN) is best when you need the cash right now since it locks in a fixed interest rate, while a home equity line of credit (HELOC) is better when you want credit available for when you need it since you only pay interest on the outstanding balance.
Small business owners frequently ask which is best because home equity loans and lines of credit both use your home as collateral and have attractive interest rates compared to other business loan options. This also makes both great options for new companies that don’t have a business credit score or the financial history to qualify for other types of business loans.
Both come with the risk of losing your house, so neither is a good option for high-risk business investments like introducing a new product line or taking your business international. Even if you’re starting a new business with a proven model, like buying a franchise, a better financing option might be out there. SBA loans have comparable rates with large amounts of financing available and are equally appealing as the money can be used for almost any business case, even buying high-value real estate.
When you are confident in your business plan or investment opportunity, here’s an overview on both loan types and when to choose a home equity loan or a line of credit.
| Home Equity Loan (HEL) | Home Equity Line of Credit (HELOC) | |
| Features | Lump sum of cash up front Fixed interest rate Interest charged on full amount over life of loan | No requirement on how much to borrow at any time Variable interest rate Interest charged only on outstanding amount |
| Benefits | No risk of rising rates Predictable payment amounts | Flexibility to borrow all, some, or nothing at any point in time Long-term opportunity to boost credit score |
| Risks | Can lose home if you default Opportunity cost of potentially falling rates where you could have saved on interest | Can lose home if you default Rising rates can increase your expenses |
When to choose a home equity loan over a line of credit
You want to choose a home equity loan over a line of credit when you’re unlikely to get a better rate in the near future and you can put all of the money to work right now. This way, you’re not paying more interest than is necessary. Make sure these two statements are true:
- Interest rates are stable or likely rising in the future.
- You need a lump sum of cash now.
Home equity loans are similar to mortgages, as you borrow the full amount today and lock in your rate. This makes them a better choice than a line of credit for long-term investments like:
- Starting a company: Using your house as collateral lowers risk for the lender and gets you a low interest rate, or helps you secure the loan when you’d otherwise be denied.
- Making large investments, such as buying a competitor’s business: A home equity loan gives you a lump sum you can use to buy the business with a low rate.
- Paying off other loans your business has at higher interest rates: If the rate on your home equity loan is lower than the rate on an existing business loan, you’ll save the difference in interest expense.
Home equity loans are also better than a HELOC when interest rates are rising since you can lock in your rate for the length of the loan, whereas your rate would adjust higher and cost you more in interest with a HELOC in the same situation. This also makes home equity loans the better choice if you know you’ll need the money in the future and a higher future interest rate will make the loan too expensive.
When to choose a line of credit over a home equity loan
Because you only pay interest on the borrowed amount, choose a line of credit over a home equity loan when rates are stable or falling and you don’t need all of the money right now.
A good example is when you need $10,000 in seasonal inventory. You can get a total line of credit for $100,000 in case you need more later. You pay interest only on the initial $10K borrowed and you still have $90K available without having to wait through another application process.
If you sell through your inventory quickly, you can choose to purchase more using that same line of credit, or you can take out a customized working capital loan.
You can also get the added bonus of a higher credit score by using only a portion of your line (assuming you make on-time payments) since a factor in your business credit score is the amount of credit used vs. what you have available. A home equity line of credit is also better than a home equity loan when rates fall, because your HELOC rate will adjust lower and save you money compared to the fixed rate on a HEL.
While both home equity loans and lines of credit can be good options for new business owners and companies without a strong financial history, they might not be worth the risk of losing your home. This is especially true for businesses that can qualify for small business loans or business lines of credit or companies that have other assets to use as collateral.
To see your available business loan options before putting your home on the line, click here and we’ll match you with the top recommendations for your financing needs.
