Can a business lender come after your house? The short answer is: it depends on what you signed. When you negotiate a business loan, the bank may want to secure the loan with collateral. If you put up your home as collateral for a business loan, and you default on it, they can foreclose on your house and your business assets. So the real questions are what you pledged, and whether anything can still be done about it.
Your Personal Home as Collateral
In some states, it’s now de facto practice for a bank to ask for your personal home as collateral on a business loan. Many business owners, particularly those who are just getting started, put most of their net worth into their homes. So you can see the bank’s thinking - it looks like their sure thing. If you’re borrowing from a bank or some other non-bank lender, they’ll take every scrap of collateral they can get to secure the loan. It doesn’t matter if it’s needed, they’ll take it. As a result, they may end up holding collateral worth twice as much as the loan (or more).
In the beginning, the idea that home owners had to pledge their homes to get loans may have seemed like the banks were doing owners a favor, that a home provided something to pledge. But that changed, and now it has simply become the norm. A bank, of course, has to have a certain amount of collateral to back a loan. But the idea of pledging twice the loan value, with the owner’s home among the pledge is just not a good way for a commercial bank to act.
Not all states allow it. In Texas, borrowers can’t use the equity in their home as collateral for a business loan, and at least one banker who spent a whole career there calls that a very good law. There is no reliable, comprehensive data on what percentage of states allow it, or which states allow it only with restrictions.
Negotiate an Offer in Compromise
A longtime commercial banker who later helped struggling borrowers in Washington, Louisiana, Massachusetts and California described three such cases. All three had thriving businesses before the recession. One operated in a community that has suffered two major natural disasters in the past three years; the other two were crippled by the abysmal local economies. Business sales tanked, and the banks started foreclosing on both business assets and the owners’ homes.
All of them asked him to negotiate an offer in compromise with the bank: Take the company’s assets but leave my home alone. None of them had taken the house off the collateral when they took out their loans. Maybe they just didn’t know that the problem could be negotiated.
When you’re behind and your house is collateral, the bank can foreclose on it. But as those owners understood, you can still ask the bank to take the business assets and let you keep the house, and that is where a debt settlement company can step in and help.
Moral of the story: before you sign on the dotted line, the collateral the bank will accept is negotiable. After you sign, it is extremely difficult to get anything released.
Collateral Instead of Your House
A start-up owner approached a bank in California for a loan to purchase equipment. The bank responded: we’ll loan you the money, but we want $50,000 of your home as collateral. For a $50,000 loan, where the equipment is new, and has a good orderly liquidation value, this is pretty absurd. Banks everywhere are making $50,000 loans unsecured, against only the personal guarantee of the borrower.
If the asset you need financing for is a piece of equipment, it’s probably not the best idea to risk your house. Consider leasing. Lessors will still secure the lease, but it’s typically limited to the piece of equipment you’re getting.
If you own rental properties, or raw land, or a vacation home (that you don’t actually live in year round), pledge one or more of those as collateral instead of your house. For a smaller loan, a credit union that lends for business may also be a better choice than a bank. Credit unions are owned by their members, so they’re a lot more likely than banks to leave out personal residences from their collateral requirements. CDFI lenders are another potential option.
Ask about collateral as early as you can in the loan process. First, find out if your state permits you to pledge equity in your primary residence as collateral for a loan. Then go talk to your banker and find out the bank’s position on the issue.
Okay, so is it ever a good idea to use your home as collateral? Generally speaking, no. Small business owners take great financial risks when they start a business, often undercapitalized. Regardless of what happens to the company, an owner should be able to sleep at night. If the business fails, they shouldn’t be forced to live under a bridge.
