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Business loan or use the home loan?

Business equipment loans can be difficult to come by, especially if you’re a new business with little or no trading history.

Even if you’ve been trading for a while, getting a loan can be a lengthy and complicated process requiring reams of ‘ financials’.

Little wonder small business owners are tempted to turn to their biggest asset for cash: the equity in their homes.

Equity is the difference between the market value of your property and the amount you still owe on your home loan.

Not only is it relatively quick and easy to get approval for a home equity loan, the interest rate is considerably lower compared to other types of loans.

But while they might look good on paper, home equity loans (and lines of credit) come with numerous downsides and risks. This paper explains some of these to help you make an informed decision.

The reason the interest rate on a home equity loan is lower than most other types of loans is that it is secured against your home.

In other words, if you can’t make your repayments, the lender can take your home. Essentially, you’re betting your home on your ability to pay back the debt.

Instead, you should consider a loan secured against the asset you’re purchasing. If you default on the repayments, you’ll lose the asset but will still have a roof over your head.

While the interest rate is lower, the term of a home equity loan (25 – 30 years) is much longer than a typical commercial equipment loan.

Let’s look at an example…

Example

Because adding debt to your mortgage is easy, it can become a habit.

While this might be OK while house prices are rising and interest rates remain low if the former falls and the latter rises, you could end up with negative equity—a mortgage that is higher than the house’s value.

You’ll be deeper in debt and won’t be able to turn to your house to provide relief.

A rising variable interest rate could also make it difficult for you to meet your repayments, potentially leading to default.

When you add the commercial equipment to your home loan, the size of the loan will obviously increase. Depending on how much it increases the bank might sting you with a higher interest rate due to you having less equity in the property (this is called loan-to-value ratio).

In other words, the savings on $30,000 worth of business equipment may be outweighed by the extra cost of a higher interest rate on all of your mortgage debt.

And this increased home loan size could hamper your ability to remortgage in future (should you decide to move house or switch lenders).

If you are looking at starting or growing your business with the purchase of financed goods, please get in contact with us so we can help find a solution that works for you.

Dim – The Bare Broker

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