By Robert Freedman, Senior Editor, REALTOR® Magazine
The pressure on home equity has been tough on everybody since the downturn but one segment of the population that’s been especially hard hit is the small business owner. Thanks to tight underwriting requirements by lenders, small business owners have been struggling to get capital just to keep their doors open. With lenders closed off to them, the only place left for them to go for capital is their own assets. That means tapping their savings or retirement accounts or their home equity, which is often their biggest source of wealth — or at least used to be. With home prices still struggling to recover in many markets, even that source of funds isn’t what it used to be. Yet many lenders won’t even consider giving business owners a loan without tying it to the equity they have in their homes.
“Much to my chagrin, I needed to put my home up as collateral for my lender to even approve my business line of credit,” says Karen Elkin, the owner of a small architectural glass company in Alexandria, Va.
Elkin, whose home is paid off, just took out a $150,000 line of credit to move her business to another location. Having to tie her business line of credit to her home equity wasn’t a deal-breaker for her because the appraisal on her home came in far enough above the loan amount that the lender was willing to provide the financing, but for other owners or for entrepreneurs who are hoping to start a business, the numbers might simply not add up. An entrepreneur whose home has fallen in value to, say, $175,000 is unlikely to secure a start-up line of credit for anything near that amount because of lenders’ concern over whether the home value will be there if the entrepreneur can’t pay back the credit.
NAR Chief Economist Lawrence Yun says the drop in home equity is one of the reasons business start-ups have fallen so significantly over the past several years. Figures from the U.S. Census Bureau show start-ups falling from 550,000 to 400,000 between 2006 and 2009, the lowest level since at least 1980.
How important is home equity to small business owners? Figures from two separate surveys reported on by the Federal Reserve Bank of Cleveland show between 20 and 25 percent of business owners use home equity to secure business credit.
Lawmakers recognize the gravity of the problem. President Obama at a rural economic summit in Iowa this past summer said he has met with small business owners and heard firsthand how tight the credit picture is. He attended the summit with Karen Mills, the administrator of the U.S. Small Business Administration, and he talked about the role SBA can play in helping businesses get loans. But out in the field, many business owners say SBA isn’t as user-friendly as it could be.
The key to turning this situation around is housing price stabilization. Once sales improve steadily over time and prices shore up, more owners will have the equity to get the business financing they need. That means the marching order for lawmakers is clear: don’t impose rules that could keep housing markets from improving. The proposed qualified residential mortgage (QRM) is just such a rule. So is any effort to reduce the value of the mortgage interest deduction. As Yun has put it, “We need to not place any obstacle to home price recovery.”
The credit challenges facing small business owners is explored in the four-minute video above.