Using Personal Loans to Finance Your Small Business
The Pitfalls and Plusses of Business Loans.
How badly do you want to start up your small business? Is it worth your home?
According to the Small Business Administration 95% of small start-up companies are financed via personal loans, such as home equity loans. For many individuals the cost of starting their own small business and being their own boss is limitless. However the cost of borrowing from friends and relatives is much too stressful. That’s why it’s an easy decision for them when the time comes to finance the dream of owning a small business.
Your home is likely the largest purchase you’ll ever make in your lifetime. That’s why when the time comes to borrow money for your business, a home equity personal loan may be your best.
If you’re determined to get your small business off the ground, there isn’t much that will stop you; however you should be aware of the pros and cons to mixing your personal and business finances.
The pros of using personal loans for business financing
The top plusses of taking out a mortgage, or what’s otherwise known as a home equity personal loan, to finance your small business include:
- It’s a whopper of a loan – As you’re well aware home equity loans yield relatively large loan amounts because they’re based on the value (or equity) of your home. Of course your home equity loan will deduct any existing liens (any portion used as collateral towards the payment of a debt).
- Low interest rates – Home equity loans typically carry low interest rates because your home is the collateral on the loan. If you don’t pay back the loan, you lose your home, so to creditors you are a pretty safe bet for repayment.
- You receive tax deductions on interest payments – With a home equity loan you have one advantage over other personal loans and business loans – you can take advantage of tax breaks on your interest payments. The money you save in tax breaks can go towards repaying your home equity loan.
The cons of using personal loans for business
Ok, we’ve talked about the pros of using a personal home equity loan to finance your small business and you were almost sold – but wait, there are always negatives:
- Up front fees – One disadvantage to using your home to secure your personal loan for your small business is that you’ll likely be charged fees up front – such as the closing costs that you would typically pay on a mortgage.
- Balloon payments – This refers a large lump sum that you will be expected to pay at the end of your borrower’s agreement. Many personal home equity loans require hefty balloon payments in order to close the loan. If you do decide to go with a home equity loan that requires a balloon payment at last payment, just make sure that you save enough to cover it. You don’t want to have to borrow more money to cover the balloon payment or risk thousands of dollars in interest to cover a payment. Some home equity loans will let you pay down larger monthly payments in lieu of a large balloon payment at the end.
- You risk the roof over your head – There are risks with absolutely any loan – you risk not being able to make payments, etc. However with a home equity loan you are risking your home. If you can’t pay the loan back you risk both house and business. Ask yourself, is it worth it?
Tips for securing a personal loan to fund your small business
The best tip that I can give you is to do your homework. Home equity personal loans differ greatly depending on your lender. That’s why it’s important to know what you’re agreeing to – before you put you home up as collateral.
You can start researching home equity loans to finance your small business using the following tips:
Do the research – It’s a big decision, and risk, to put your home up as the collateral for a loan to finance your small business. Before you put pen to paper and sign anything, make sure you understand what you’re signing. If you don’t, ask as many questions as you have to until you fully understand your borrower’s agreement.
Are you comfortable with your decision? If you’re still not comfortable, there are always other options. For instance you might feel more secure risking your home if the payments were set at a fixed interest rate, fixed payment schedule like with a second mortgage. Or you could look into taking out a line of credit that won’t ask you to put up your home as collateral. Just remember that lines of credit carry much higher interest rates compared to home equity loans. Plus you typically have to establish that your business is already profitable in order to take out a line of credit or a business loan.
Convince the lender – I know you’re convinced that you have the best business plan since sliced bread, but convincing your lender is another story, and they’re the ones that hold the purse strings as far as credit goes. If you are looking to fund a business that is already making money – for instance something you’ve been doing in your spare time – then you need to show the lender that it’s profitable. When you go to the bank or lender to apply for a loan, bring copies of the following:
- Income statements
- Balance sheets
- Future income projections
- Costs – monthly payments, office space and financial risks.
- Business assets – this would be the personal assets of you (as owner) and your partners (if you have any).
The business plan – If you haven’t yet started making money on your small business that’s ok; however you still need a detailed business plan outlining exactly what the personal loan will be used for. If a lender sees that you’re business shows profitability they will be more inclined to lend to you. A proper business plan should include:
- How much money you need
- What the loan will be used for
- What type of loan you want
- Your personal assets (collateral)
- Projected business income over the next year
- Potential business risks or liabilities
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