Using home equity to buy a business

Available equity is the lending limit less the existing debt. On a home valued at $900,000 with a $350,000 loan, 80% of value is $720,000, so up to $370,000 may be available. The lender orders its own valuation, and the figure it adopts can be lower than an agent's estimate. The new borrowing is usually set up as a separate loan split, either with the current lender or through a refinance. The general process is the same as any equity release, with extra questions because the purpose is a business purchase.

Lenders want to know where the money is going. Expect to provide the sale contract or heads of agreement, the financial statements of the business being bought and your own income evidence. Some residential lenders restrict cash out for business purposes, in which case the loan is written as a business loan secured by residential property. Servicing is tested on your current income, and some lenders will also count the maintainable earnings of the business you are buying. If you are leaving a salaried job to run the business, the lender will not rely on that salary.

The main advantage is the loan term. A loan secured by residential property can run for up to 30 years, often with an interest-only option for the first few years. A loan secured only by the business is commonly repaid over three to ten years on a principal and interest basis. On the same amount of debt, the longer term produces much lower monthly repayments, which takes pressure off cash flow in the first years of ownership. Pricing is usually lower as well, because residential property is the security lenders value most.

A long term has a cost of its own. Business debt spread over 30 years attracts far more total interest than the same debt repaid over seven, and the business may be sold long before the loan is cleared. Many borrowers take the long contractual term for safety and make extra repayments in line with a shorter target. How each option compares is covered in secured vs unsecured loans to buy a business.

The home secures the debt regardless of how the business performs. If the business fails, its goodwill may be worth nothing, but the loan balance stays and the repayments continue. If they cannot be met, the lender can take possession of the property and sell it. Mortgage documents are often drafted on an all monies basis, which means the property can secure other debts owed to the same lender, including business overdrafts and guarantees. Loans for business purposes also generally sit outside the consumer credit laws that apply to ordinary home loans, so some protections borrowers assume they have may not apply. A solicitor should review the documents before signing.

A mortgage can only be granted by the registered owners of the property. If the home is jointly owned, both owners must sign the mortgage, even if only one of them will own or run the business. Where the borrower is a company or trust, the lender will usually also ask the property owners and the directors to give personal guarantees. A spouse or partner who has no role in the business and signs as a guarantor is treated carefully by lenders. Most require that person to obtain independent legal advice, and sometimes independent financial advice, and to return a signed certificate before settlement. A guarantor can be pursued for the full debt if the borrower defaults.

As a general principle, the tax treatment of interest depends on what the borrowed money is used for, not on which property secures the loan. Interest on funds used to buy an income-producing business may be deductible, while interest on the private part of a home loan is not. Mixing the two in one loan account complicates the records, which is why a separate split is normally used. Whether the borrower should be an individual, a company or a trust, and how the funds should be lent into the business, are tax and legal questions. Get accountant and legal advice before the loan is documented. Lending options beyond home equity are covered on the loans to buy a business page.