Housing prices are on the upswing, increasing 9.3 percent between February 2012 and February 2013, the Wall Street Journal reported last week.
That’s not just good news for America’s homeowners. It’s also welcome information to America’s small business owners.
The drop in home prices has crimped some small companies’ access to credit. According to Barlow Research’s Quarterly Economic Pulse Survey, 26 percent of small businesses with between $100,000 and $10 million in annual sales used the home equity of the company’s owner or largest shareholder for business purposes in the third quarter of 2012. That fraction was nearly identical to the one recorded in 2007 when Barlow’s survey showed that 25 percent of small businesses in this size range tapped home equity for business purposes.
While the fraction of small business owners using their homes as a source of credit for their businesses is the same now as before the housing bust, financial crisis, and Great Recession, the amount that small business owners are able to borrow against the equity in their homes has dropped substantially.
Business owners are seeking to borrow against homes that are worth considerably less than before the housing bust. According to the Federal Reserve’s Survey of Consumer Finances, the typical home owned by a household headed by a self-employed person decreased 14.1 percent in inflation-adjusted terms between 2007 and 2010.
The amount of small business owners’ home equity has likely fallen. While information on the value of business owners’ equity is not broken out separately in any government statistics the way that home values are, they have likely followed decline similar to that for all homeowners’ equity. According to analysis of data from the Federal Reserve’s Flow of Funds Accounts, “homeowners’ equity in household real estate” decreased 28.2 percent between 2007 and 2012, when measured in inflation-adjusted terms.
Not surprisingly, the value of outstanding home mortgages has declined alongside the value of homeowners’ equity. The Fed’s Flow of Funds Accounts data show a 19.2 percent drop in real terms over the same period.
The one quarter of small business owners who rely on home equity to finance business operations have been forced to cut their home equity borrowing as the value of that equity has shrunk in recent years. While the fall in home values is not the only factor constraining small business borrowing, it has contributed tight credit conditions in the small business sector – conditions that may account for weak hiring and contribution of the sector to economic growth in recent years.
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While I would prefer SMBs not use their homes for credit it’s helpful to see any progress in obtaining credit.
It’s certainly interesting to see the significant percentage of owners who use home equity for their businesses. Of course, there are probably a couple ways to look at these numbers. I’m guessing the percentage of business owners tapping home equity would be lower if home values were lower, but I’m also wondering whether that percentage would be lower if business was better.
The fraction of small business owners tapping home equity is the same in 2012 as in 2006 and 2007 before the housing price collapse, financial crisis and Great Recession.
While the fraction of borrowers is the same, the amount of homeowners’ equity is way down. As a result, the amount that those borrowers can tap is also way down.
Hi Scott. Thanks for the clarification.
This is a very high risk strategy.I have seen many people do this.If they loose,they are out of their home,their families break up.
I have a different model.
For service industries I advise cash sales with 1 % discount.For corporate accounts I advise 0.5 % net 10 days.Same policy for Government.
A small business is not a finance arm.If a client wants financing then have a bank do it for them.