In basic terms, home equity loans are type of loan through which a person uses the equity in his or her home as collateral.
Equity represents the difference between the amount of any outstanding home mortgage loan and the appraised value of the residence. The lender obtains a lien on the real estate in the same manner as the original mortgage loan lender.
Typically, a home equity loan (also called a second mortgage) is used to obtain funds for home improvements, a child?s college education, to consolidate other debts and the like. The proceeds from a home equity loan can be utilized to fund a small business enterprise.
Funding a Small Business with a Home Equity Loan
The mechanics of funding a small business with a home equity loan are relatively simple. An application is made to a financial institution for a home equity loan or second mortgage. Provided a person has a consistent track record of making mortgage payments in a timely manner, and assuming a cushion in the form of equity remains after a home equity loan, a bank likely will agree to the financing proposal. In the end, under this set of circumstances, a financial institution is not entering into a risky loan agreement.
Once the loan is approved and funds dispersed, the money is then available to be transferred to the small business for its use.
Requirements for Obtaining a Home Equity Loan to Fund a Small Business
As noted previously, one of the essential requirements is a good track record of making the primary mortgage payments in a timely manner. In addition, a financial institution will want to verify that the borrower has a source of income, including possibly a source of income in addition to the small business for which funding is sought.
Keep in mind that if a small business owner is married, the spouse will need to be a party to the home equity loan, even if he or she is not directly involved in the operation of management of the small business.
The Propriety of Funding a Small Business with a Home Equity Loan
The reality is that in challenging economic times, more traditional and direct means of financing are not always readily available to small business. Some banks tend to be leery about lending money to a small venture, particularly a start-up business with no established track record.
Understanding these constraints, using a portion of the equity in a home to obtain a loan for a small business may make sense. A person is well advised not to use the entire equitable balance to secure a loan proceeds for a small business. Some type of personal or family emergency could arise necessitating the needs to tap into a home?s equity to obtain funds.
Tax Consequences of Using Funds from Home Equity Loan for a Small Business
The IRS permits a full deduction by the business for the payments it makes on the loan, despite the fact that the financing originated as a home equity loan or second mortgage. The loan payments are considered a legitimate business expense.
Consult a Professional
On a final note, before transferring funds obtained from a home mortgage loan to a small business, consulting with a tax accountant or attorney is a crucial order of business. The transfer must be done in accordance with applicable federal and state laws, information which is available from a professional experienced in business and tax law as well as accounting.
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