The Source of an Equity Injection: Using a Home Equity Line of Credit (HELOC)

Bob TannenhauserSmall Business Lending

Small business lenders weigh many factors in determining whether they will make a loan to a small business owner. One of those factors includes the potential borrower’s equity injection. Lenders, however, will not only look at the amount of that injection, but will also want to know its source. Where is the equity injection coming from?

Cash that is not borrowed is obviously the most preferable option. But what if the small business applicant wants to use a HELOC as the source of her equity injection? For SBA loans above $350,000, a borrower may use a home equity loan as long as she can demonstrate that the debt will be repaid with income outside of the business.

But just because the SBA permits it doesn’t mean that a lender will accept it; or even if it’s a good idea for the borrower.

 

Here Are Several Negatives To Consider:

1)   A borrower may very well need capital if and when something goes wrong in the business or personally.  If she can’t access money from other sources, a HELOC may be the only viable source of capital. A borrower may not have access to available capital in a HELOC if it was used as the equity injection in securing the small business loan.

2)  A borrower may be highly leveraging her house, putting her home at jeopardy. Furthermore, in assessing the overall viability and risk level of a potential borrower, lenders may not like to see that the borrower is highly leveraged.

3)  Taking out a HELOC may hurt the borrower’s individual credit score as well as SBSS small business credit score (available at bQual.com, a website that allows small business borrowers to quickly have access to the credit scores and information lenders use to make loan decisions).

4)  The HELOC will lower the applicant’s net worth, especially if she does not have a lot of assets.

On the other hand, one clear benefit of using a HELOC as your cash injection is that it may allow you to secure a small business loan that you might otherwise not be eligible for without it. It may, in other words, be one’s only option.

 

Another consideration is that the source of an equity injection may not be so clear. Take, for example, the following scenario:

A person earns a salary and deposits it into a bank account. He also takes out a HELOC and deposits it into the same account. He then proceeds to apply for a small business loan, citing the bank account as the source of the equity injection.

Is that money coming from the salary? The HELOC? It may not be entirely clear. Such vagueness may cloud the source of an equity injection since the total monies have been sitting in the same bank account. There is no clear line of demarcation.  However, lenders will look at several months of bank statements and will want to understand where large deposits are coming from. It is always best practice to clearly identify sources of money in your accounts for lenders as they analyze your loan request.

(In addition to a HELOC, a regular home equity loan may be used as an equity injection, provided, similar to a HELOC, that it will be repaid with money other than the business’s cash flow. Depending on interest rates, a standard home equity loan (term loan) may be preferable to a HELOC.)

 

The decision to use a HELOC as an equity injection when applying for a business loan should be carefully considered. As indicated above, there are several cons to taking that route. It remains, however, a potential option should a borrower not have access to any other capital.