September 19, 2014

The Micro Business Home Equity Loan Crunch

Home equity

To obtain the capital they need to finance their business operations, some micro-business owners tap the equity in their homes by drawing on home equity lines of credit. But in recent years, this strategy has become more difficult for business owners, as banks have cut back on home equity lending.

Seventeen percent of businesses with less than $100,000 in sales use home equity lines of credit for business purposes, Barlow Research’s October 2012 Small Office/Home Office Opportunity study – a random sample of 100,000 small businesses with less than $100,000 in sales listed in Dun and Bradstreet – reveals.

That’s surprisingly high. The Federal Reserve’s 2010 Survey of Consumer Finances reveals, that 18 percent of the self-employed don’t own their own homes, so they can’t get home equity lines of credit. The National Federation Independent Business’s 2011 Annual Finance Survey shows that only 44 percent of businesses with fewer than 20 employees have a line of credit, whether drawn on their home or otherwise. Together these numbers suggest that just under half (47 percent) of micro business owners with homes and lines of credit made use of home equity to get the credit line.

In absolute terms, a lot of micro enterprises use home equity lines of credit for business purposes. The Internal Revenue Service estimates that there were approximately 25 million businesses with less than $100,000 in revenue in operation in the United States in 2008, the latest year data are available. Given Barlow Research’s estimate of the fraction with home equity lines of credit used for business purposes, that translates to more than 4 million micro business owners.

These 4 million business owners have had a tough time with their financing strategy in recent years because of the declining home equity loan market. According to the Federal Reserve of New York’s Quarterly Report on Household Credit, the number of home equity lines of credit fell from 23.9 to 18.7 million between the fourth quarter of 2007 and the fourth quarter of 2012. Moreover, the amount of credit available on home equity lines of credit declined 39.3, and the balance on these loans 24.1 percent, percent in inflation adjusted terms, over the same period.

As I have argued before, small business credit markets are linked with the housing market. During the housing market boom, micro business owners had an easier time getting credit for their companies because they could tap rising home equity levels. Since housing prices have deflated, however, and banks have cut back on home equity loans, microbusiness owners who used home equity to finance operations have found credit more difficult to get. If policy makers want to help ensure that microbusiness owners have access to sufficient credit, then they need to keep a careful watch on the housing market.

Home Loan Photo via Shutterstock

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Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

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