Using Home Equity to Buy a Business
Financing Your Dream Business
Prospective business buyers are always looking for innovative ways to come up with the money to start a company or acquire an existing one. If you want to , your choices may be limited based upon what you own, what you owe, how good your credit rating is, and what sort of incentives the seller may be willing to offer. The smart business buyer will look carefully at every opportunity, selecting the one that offers the most “bang for the buck.” In some cases, the best option to finance your business purchase is right under your feet—if you’re standing in your living room, that is. The home equity loan is definitely worth exploring.
What is Home Equity?
According to a fairly reliable online resource, home equity is “the market value of a homeowner’s unencumbered interest in the … property.” In layman’s terms, it is the current value of your home minus what you owe on it. For example, if your house is worth $450,000 and your mortgage balance is $200,000, then your home equity is $250,000 (or 55.6 percent). Banks or similar lending institutions, such as credit unions, typically provide home equity loans.
Home Equity Rules-of-Thumb
Before risking the equity in your home on a business venture—after all, starting or is a risk—it pays to take a close look at things like home equity loan rates, the value of your residence, and how much you will need to fund that business. The home equity rate will fluctuate based upon the current mortgage market, and it can also vary depending upon the size of the loan and your credit rating. But the first exercise should involve seeing if a home equity loan is the right thing to do. Begin by obtaining a current appraisal on your home. Subtract from that figure all outstanding mortgages and other debts associated with the property, which might include liens. Divide the equity total by the appraised value. If that number is 50 percent or more, it will be worth taking the next step in the process. A business advisor—whether , accountant, or business attorney—can advise you on how much money you will need to make the business purchase. After determining the cash payout of the loan, your lender will then quote you current home equity rates and calculate a monthly payment.
Getting Creative With Cash Flow
Once your banker has given you a monthly payment figure, it’s time to do some business forecasting. Having done your research ahead of time, you should have a fairly good idea as to what kind of monthly income your new business will generate. Subtract out your monthly expenses and you come up with your net profit. In most circumstances, you will be paying off your home equity loan from pre-tax operating income. Your CPA or personal tax advisor can suggest the best way to account for these payments. In certain situations an owner will draw a salary equal to the monthly payment, or else make a personal loan to the business and have the company repay it in lieu of a salary. Oftentimes interest payments offer a tax savings, both for the borrower (you) and the company you own. These laws can be quite complex, however, and every situation will be different depending upon the type of corporation you formed when starting the business, and how the loan was written. Expert advise in all cases is well worth the money you will spend to receive it.
Alternatives to Home Equity Loans
If you are buying an existing business, several alternatives to obtaining a home equity loan may be available. In some cases, the seller may be willing to provide financing on part of the purchase price, or even the entire amount. There is also the prospect of an SBA ( Administration) loan, where the federal government guarantees the payback of the loan in the event of a default. The best plan may actually involve multiple options, especially if the cost of buying the business is steep. A home equity loan can be a strong weapon in your business-buying arsenal.
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