Why Businesses Use Different Types of Equity Loans for Expansion

What is an equity loan?

An equity loan is a type of debt that is secured by your equity in another asset, which is put up as collateral. For some small business owners, that collateral asset is their home.

Your home's equity is the difference between the value of your home (what the property is currently worth) and what you still owe to your mortgage lender. So, if your home is worth $500,000 and you still owe $300,000, you have $200,000 in available home equity.

Now, not all of that equity is necessarily available to borrow against, but a good portion of it might be, depending on the lender and type of equity loan you choose. Lenders may let you borrow a combined loan-to-value (LTV) ratio of up to 80% or 85% of your home's value. This means that your mortgage loan and any equity-based borrowing (like an equity loan) combined can together equal as much as 85% of your home's value. The exact amount you can access depends on your credit score, your debt-to-income ratio, and the lender's underwriting guidelines.

Using home equity for business expansion isn't a new idea; small business owners have been doing it for decades. What's different today are the types of equity loans available and the wide range of financial situations they're suited for.

Types of equity loans for business expansion

There are a few different types of equity loans that you might consider using to expand your small business. Here are a few of the most popular.

1. Home equity loan

A traditional home equity loan offers you a lump sum of cash, secured by (and borrowed against) the equity in your home. It typically comes with a fixed interest rate, fixed monthly payments, and a set repayment period, which is often somewhere between 5 and 30 years.

For business expansion purposes, a fixed-rate home equity loan works well when you have a specific expense or project in mind: you're looking to buy a piece of equipment, tackle a build-out, make a bulk inventory purchase, or need a down payment for a new property or to buy out another company. In this case, you know exactly how much money you need, you're able to borrow it once, and you can pay it back in predictable monthly instalments.

Home equity loans are technically second mortgages, which means they sit behind your existing mortgage in terms of priority. If you were to ever default, the collateral property (in this case, your home) may be subject to foreclosure; your primary mortgage lender would get priority claim on any proceeds while your equity lender would be repaid from the remaining amount.

That's an important detail, which mostly matters when it comes to the interest rates you're offered. Since second mortgages are secondary lienholders, this type of equity loan option usually comes with slightly higher rates than first mortgages. They're still considerably lower than forms of high-interest debt, including most unsecured business loans, personal loans, or credit cards.

One bonus? The interest on home equity loans (when used for business purposes) may be tax deductible, depending on how the funds are used and your overall tax situation. Just be sure to speak with a tax professional to confirm your situation and financing options with this type of equity loan.

2. Home equity line of credit (HELOC)

Another type of equity loan is the HELOC, or home equity line of credit. A HELOC works differently from a home equity loan: instead of borrowing a lump sum upfront, you get access to a revolving credit line that's secured by your home's equity. Just like a credit card, you can pull from this credit line as needed; once you pay down what you borrowed, you can draw from the line again.

A HELOC draw period typically lasts 5 to 10 years, during which time you can borrow up to your credit limit and make interest-only payments on whatever you've drawn. After the draw period ends, your HELOC enters a repayment period; you'll be forced to pay down the remaining balance with more typical principal and interest payments.

HELOCs usually have a variable interest rate, which means your monthly payments can fluctuate as interest rates (like the prime rate) change. Some lenders will let you "lock" a withdrawal at a fixed interest rate, but it's still subject to current rates and other fees (like annual fees, lock fees, etc.) may apply.

When it comes to business expansion, a HELOC is particularly useful type of equity loan when your funding needs are ongoing or variable rather than a one-time expense. Things like hiring new staff over time, funding a fluctuating inventory cycle, covering new product launches, or just managing cash flow needs through slow seasons are all situations where having flexible access to capital is more valuable than borrowing a lump sum once. With a HELOC, you draw what you need when you need it, and you only pay interest on what you've actually used.

3. Cash-out refinance

Cash-out refinancing replaces your existing mortgage with a new, larger loan, pulling the difference out in cash that you get at closing. It's not technically a second loan on the same property the way that a home equity loan is. Instead, it's a brand-new mortgage that is simply bigger than the one it replaced.

Think back to the example above, of a $500,000 value home with a $300,000 mortgage loan. In this case, you could take out a cash-out refi loan for $400,000; this $400,000 would be used to both pay off your original mortgage lender and provide you with $100,000 in cash, and you'd pay down the debt with a new monthly mortgage payment.

Because cash-out refinances are first mortgages, they may have lower interest rates than home equity loans or HELOCs. So, if you're going to borrow a large amount for a major business expansion (like opening a new location, making a big equipment purchase, or acquiring a competitor's business), refinancing can give you access to the most cash at the lowest rate.

Equity loans vs. traditional business loans

So, why would small business owners turn to different types of home equity loans for expansion rather than taking out traditional business debt? It all comes down to cost and access.

First, interest rates on certain types of equity loans (home equity loans, HELOCs, cash-out refinances) are generally lower than rates on unsecured business loans, SBA loans, or business credit cards. The reason is simple: your home is tangible collateral that the lender can seize and sell if you default on that debt (called a foreclosure). This lowers the lender's risk, and lower risk translates to lower interest rates for the borrower.

Lenders are also willing to offer larger loan amounts when debt is secured by a personal home, compared to when it's backed by business assets alone. That reason is also simple: most people are going to do everything in their power to avoid losing the roof over their heads, so default rates are generally lower. A business that doesn't yet have years of financial statements, strong business credit, or significant assets may find it easier to qualify for a home equity loan than a similar unsecured business loan.

The flip side of this is that, yes, your home serves as the collateral. If your business expansion doesn't go as planned and you can't keep up with loan payments, the risk isn't just to the business... you could lose your home.

Final thoughts

Different types of equity loans give small business owners access to capital that they can use for business expansion, at lower interest rates and with larger loan limits than most traditional business financing. The reason is the collateral: your home gives lenders confidence that this debt is backed by something real (and important to you), and they set the loan terms accordingly.

That same rationale is also the biggest risk. Raising funds for business expansion through home equity loans, HELOCs, and cash-out refinances makes sense when your business plan is solid. But it deserves careful thought when the expansion plans are shaky or when the monthly payment on that new debt would be a strain, regardless of how the business performs.

For business owners who have significant home equity and a clear plan for how to use it, these types of equity loans could be worth exploring. Just be sure to compare them to traditional business lending options before you decide.