Whether you have a million-dollar idea that needs funding, or need to inject a bit of capital into your existing small business, you’re might be weighing the pros and cons of various small business loans. Not only are there plenty of small business loan options out there, there are heaps of personal loan options you can go for to finance your company—one of which is a home loan. But trying to decide between a business loan vs. home loan is a tricky process.
The business loan vs. home loan debate may depend on a series of factors, but it’s easy to choose the right one for your company when you ask yourself the right questions. You’ll need to weigh out your personal and professional financials, the kind of company you operate, and how much personal risk you’re willing to take on. Here’s what you need to know to solve the business loan vs. home loan debate.
There are distinct differences between business loans and home loans—and distinct advantages and disadvantages to both.
There are quite a few factors that differentiate business loans and home loans. First, home loans typically take three distinct forms: mortgages, home equity loans, and a home equity line of credit.
Mortgages are only for purchasing property you intend to live in. The terms of a business mortgage loan explicitly require you to use your loan funds toward your mortgage, which means you can’t use mortgage funds to help finance business or other personal expenses. So, if you were looking to get a mortgage to help finance your business—even if it was to purchase commercial space—think again.
Pros: Offer low interest rates and long repayment terms for purchasing a home.
Cons: Mortgages can’t be used for any other purpose but to buy a home, condo, apartment, or other dwelling you plan to live in.
Home equity loans are similar to mortgages, but instead of providing money to buy a home, they provide borrowers with money based on the value of the home they’ve already purchased. Although many home equity loan borrowers use these funds to pay for home improvement projects or repairs, more than a few entrepreneurs use them to finance their businesses. Some small business owners take out home equity loans against their homes instead of business loans. Usually, entrepreneurs opt for home equity loans if their credit isn’t stellar, are just starting their business, or need quick access to cash.
Pros: A quick, easy source of cash that can be used for personal or professional purposes.
Cons: If you can’t repay the loan, you may have to forfeit your home. Plus, if you use your loan for business purposes, you’re mixing business and professional finances (which isn’t usually a great idea).
Finally, we have the home equity line of credit (HELOC). HELOCs offer borrowers an opportunity to borrow up to a set amount of cash, only taking out what they need, when they need it. This option allows people to borrow—and pay for—only the amount of money they need throughout the life of the line of credit. That also means borrowers can keep interest rate payments low, since they’re not paying interest on the full amount of money that the lender is willing to provide—just what they’re actually using.
Pros: HELOCs don’t require you to borrow more money than you need at any given time, and you can take out money through your HELOC several times and repay as you go.
Cons: You’re still borrowing against the value of your home, which means you could lose it if you can’t repay your debts.
There are quite a few business loan options to help finance your business throughout every stage of its growth. Most business loans are harder to get than personal loans. However, business loans also offer safer terms than home loans in the event that borrowers can’t pay back their debts (more on that later). Here are a few of the most common kinds of business loans.
Contrary to popular belief, the SBA (Small Business Administration) itself doesn’t disburse SBA loans—that’s the role of an intermediary lender, which is often a bank. The SBA offers more of a support role in this process, since they’ll guarantee a majority of the loan amount back to the intermediary lender in case their borrower defaults. To secure an SBA loan, though, you’ll have to be approved by both the government agency and the lender issuing your loan, so the application process is more demanding, and the approval window longer, than other types of small business loans (especially those from online lenders, who boast super-fast application and approval times).
SBA loans come in a variety of sizes, terms, and purposes—too many, in fact, to list in detail here. There are options for brand-new businesses, existing companies, and even loans designed specifically to help entrepreneurs purchase equipment. These loans offer lump-sum payments with lower interest rates than non-SBA term loans, and can provide more money per loan agreement depending on your needs.
Pros: Excellent interest rates, generous repayment terms, and larger loan amounts than some term loans.
Cons: Can be difficult to obtain, and the application process requires a ton of paperwork before you can submit.
Structurally, term loans are similar to SBA loans—both are a lump sum of capital, delivered right to your business bank account, that you’ll need to repay (with interest) within a predetermined time-frame. Unless it’s specifically an SBA loan, however, plain old term loans—which you can get from your bank, credit union, or an online lender—aren’t guaranteed by the government.
For that reason, they might higher interest rates, shorter repayment periods, and offer less cash for each loan. But the terms of your (term) loan always depend upon what your lender can offer; and your business stats as presented in your application. Lenders consider factors like your industry, time in business, profitability, and credit score during the underwriting process.
Pros: Offer funds to business owners with good personal or business credit.
Cons: Can be harder to obtain if your credit is less than stellar.
A business line of credit is similar to a HELOC, except it isn’t tied to the value of your home. Instead, lenders determine a company’s eligibility for a business line of credit through several factors, including the company’s income and revenue. Just like a HELOC, though, this lending option allows small business owners to tap into additional money when they need it, without having to pay interest on the full amount of their loan. It’s handy to have one waiting in the wings to cover unforeseen emergencies (fires, floods, spoilage) or opportunities (a massive influx of new orders you need to fulfill, STAT).
Pros: Provides you with the flexibility to borrow money incrementally, only paying interest on what you borrow.
Cons: If you borrow more than you can repay, you’re still on the hook for your debts.
Equipment financing loans are a great option for small business owners who might need help paying for machinery, work-related automobiles, or other pieces of equipment they need in order to run their companies. Like home equity loans, equipment loans are self-collateralizing—meaning that the bank will seize and liquidate the equipment they’re financing if you default on your loan.
Pros: There’s no need to put up collateral for equipment loans, since the machinery you purchase with the loan serves as collateral itself.
Cons: You can only borrow the amount of money required to purchase the equipment. That, and you’ll lose it if you don’t repay your debt.
You can see that there are several differences between a business loan vs. a home loan, but the major difference to keep in mind is the liability factor.
When you borrow money against the value of your home, your personal responsibility for paying back the loan (and its interest) is much greater than it would be if you secured a loan through your business.
Say you take out a home equity loan to finance your new clothing boutique. Business is slow, inventory isn’t moving, and the financial picture of your business isn’t looking too hot. Not only is your source of income drying up, but you’re still on the hook for the total sum of your loan. If you can’t find a way to pay for your home equity loan, your lender can (and likely will!) seize your home.
Now, if you had taken out a small business loan, the bank would seize your company’s assets to help repay the money you owe—not the roof over your head. And since you thought ahead and set up your business entity as a Limited Liability Corporation (LLC), S-corp, or C-corp, your personal assets are protected. Instead, your creditor will seek repayment through your business assets, or liens on your wages at future employers—and since you didn’t put the value of your house on the line, you won’t likely lose it if your company goes belly-up.
Deciding between a business loan or a home loan should hinge on a few key factors. Chief among them are your risk tolerance, personal finances, business solvency, and what you’re looking to do with the money you’re borrowing.
Taking out money against your personal finances to help fund your business is always a risky proposition. You might have easier access to cash when you borrow against the value of your home, but you also risk losing your house if your company doesn’t make it. Even if you don’t lose your home, you’re still taking on heaps of personal liability if you run into money trouble—this is exactly what an LLC or corporation protects you from, which means that you’re taking on more risk than you really need to.
Additionally, there are plenty of financing options out there for entrepreneurs who need cash to fund their next best idea (or the next big step for their business). There’s a business loan out there for just about any kind of project, which means that dipping into your personal financial health to fund your ambitions isn’t necessary most of the time. You’re almost always better off exhausting your business loan options before using a home or personal loan to finance your business. When you keep a roof over your head despite your business going under, you’ll be glad that you did.
Brian O’Connor is a contributing writer for Fundera.
Brian writes about finance, business strategy, and digital marketing. He is the former director of digital strategy at Morgan Stanley, and has worked at Foreign Affairs magazine, Student Loan Hero, and as a partner of a small consulting firm, too. Combined, these experiences allow him to offer a unique perspective on the challenges small business owners face.