Personal loans are a great back-door alternative when seeking financing for a small business venture.
Home Equity Loans Are Often Used to Indirectly Finance Small Businesses
One of the most common means of obtaining funds for operating a small business is through a home equity loan. If you have been paying your mortgage for a few years, you have probably built up some sizable equity in your property. Bank loans taken against a personâ€™s primary residence are low risk, no matter what the funds are going to be used for. You can take the proceeds garnered from a home equity loan and use them to operate your business. Then, technically, you are financing your business, not the bank.
If you use the proceeds from a personal loan to finance your business, then you do need to make this clear on your loan application. If you lie on a loan application you have committed fraud, which is a serious criminal offense.
A great advantage of getting a home equity loan or a second mortgage on your home is that the bank is unlikely to foreclose or call the loan on just a few missed payments. Assuming you can catch up on your payments, the bank will generally just hit you with some interest and some penalties.
The disadvantage is that not only do you have the extreme risk of losing your house, but it can also create personal tension. If you are married, your spouse will probably be less than thrilled that you are risking your house to finance your business.
What Are Some Situations Where a Home Equity Loan Makes Sense?
Probably in a situation with very low risk, such as if you are buying a highly established business with steady income and strong competitive position. But, Iâ€™d first try to get the seller to finance me, even if I had to pay a much higher interest rate than I could get from a home equity loan. I just like to keep financing my business separate from financing my house.
In fact, maybe starting a business is a good time just to sell your house and either move to a less expensive place or into a rental unit and cut your personal overhead. Heck, if you are starting a new business, chances are that you are going to have a lot less time for just hanging out around the house anyway!
Can I Finance My Small Business Using My Credit Cards?
I have seen people finance a small business by running up massive amounts of credit card debt, sometimes on many credit cards. I do not recommend this. Most credit card companies charge very high interest rates, much higher than you would pay on a home equity, auto, or other kind of loan from a typical bank. Furthermore, credit card fees for late payments can be onerous, too.
Can I Use My Car to Help Finance My Business?
What about that late-model car you are driving? Do you really need a fancy new car? Is the expense or money you have tied up in it really a transportation expense or is it just another way to boost your ego? Personally, Iâ€™d rather have my equity in a growing business than a depreciating car!
My friends used to tease me about the old jalopies Iâ€™d drive. For years, I drove a partially rusted-out old Pontiac Lemans. My business school buddies called it â€śfully depreciated.â€ť I bought it for $600 and then I sold it about four years later for the exact same price! Meanwhile, I built a lot of equity in my business.
Another time I remember picking up a woman on a date in my old station wagon with an engine that was misfiring. The previous time I had taken her out, I drove my company delivery van, which made an incredibly loud shaking noise (I think the previous owner had rolled it over and damaged the roof). She asked me, â€śWhat are you going to pick me up in next time, a dump truck?â€ť
I wasnâ€™t embarrassed. I thought her remark was hilarious! Hey, if a woman or man judges you by your car, you probably donâ€™t want to go out with them anyway! And you would be surprised how it matters a lot more to your own ego than to your friends.
Finance Whatever You Have to Get Your Small Business Going
First, even before you consider taking out a loan, think of what assets you can unload, including your house, your car, or whatever. If you want to succeed in business, you have to make some sacrifices!
Takeaways You Can Use
- If you canâ€™t get a business loan, all different kinds of personal loans might be an alternative.
- Credit card debt should usually be a last resort because itâ€™s typically very expensive.
- Home equity loans or second mortgages are advisable mostly for low-risk propositions.
- Selling personal assets might be an even better solution.