Home Equity Loans – Important Information on Home Equity Financing

Homeowners have seemingly limitless choices to tap in to the equity in their homes. Many folks choose to refinance for cash out at closing, others are looking also for the benefits of a lower interest rate on their loan and cash out for repairs, unexpected expenses and other of life’s little surprises.

A home equity loan is a secured loan where you borrow against the equity in your property. Even with poor credit, a home equity loan is not difficult to qualify for. This is because unlike a personal loan, the risk to the lender is not all that great. Your loan is secured by the equity (or owned value) in your home.

Home equity loans are most commonly used for the purpose of consolidating debt and eliminating high interest credit card loans. The biggest advantage to home equity loans is that you can pay off your debt at a low fixed rate over a set period of time. This is a major advantage over revolving lines of credit, such as credit cards.

Home equity financing is also useful for covering incidental expenses such as home repairs and maintenance. Have a child heading off to college? You can get a home equity loan to cover the cost of college. Are unexpected medical bills a problem? A home equity loan can be used to pay off medical bills at a fixed rate over a long term. As you can see, the uses for home equity financing are many.

Home equity financing is the same as taking out a second mortgage loan on your property. This also means that because the home equity loan is secured by your property, you can loose your home in the event of a default on the loan. It is for this reason that you should take home equity loans seriously and take care not to overextend yourself or strain your monthly budget.

Every situation is unique but in many cases home equity loans can be a benefit to your finances. They can also you harm if you overextend yourself. Whether or not a home equity loan is right for you is something only you can decide. If you do decide to seek a home equity loan, there are numerous resources available for you to compare offers and apply for the financing.

Emergence of Equity Finance

Finance is required by every business to run and operate. Long term need for funds can be most fruitfully met by equity. Equity finance refers to the participation of general public in the ownership of the business. Equity finance is the procurement of funds by a company from the general public by issuing share certificates as ownership proof.

Equity Finance as a source of finance grew strong when the entrepreneurs searched for funds with no fixed commitment of interest/return. Then, equity finance as a mode was developed. Businessmen could then go to the public saying that the shareholders will be the owners of the business and will have a share in the profits earned. The profits were expected to be much higher than the prevailing debt market rates. Gradually, investors liking grew and they started bidding for acquiring shares of the company. This further gave rise to Book Building during the IPO(Initial Public Offer).

On the other hand,companies started enjoying the benefits in the form of freedom from fixed interest payments. Also it allowed them to raise funds with pledging/securitizing their assets. It was the cheapest and longest form of finance as the companies were committed to pay the money only at the time of winding up. The profits were paid to the shareholders in the form of dividend. Moreover,the companies could defer the payment of dividend and pay it on cumulative basis.

Global investors put on their money in the companies of developing and emerging economies and that was how growth of world economy was facilitated. Hence equity finance has proved to be a blessing for all.

Choosing Between Debt Financing or Equity Financing

Finance managers world over are faced with the choice between debt financing and equity financing when looking for finance for their businesses. Both the types have certain merits and demerits. A little demystification will perhaps help towards the decision making process.

Debt financing the pro’s and cons

Debt financing is basically when you take loans from financial institutions, banks or government agencies which need to be repaid over a fixed time period. Debt financing has certain advantages and disadvantages, which are listed below.

The positives

The lending institution or bank has no say in the internal decision making of the business and has no ownership in the business. There is a tax advantage since the interest on the loan is tax deductible and you can usually plan and incorporate the repayment in your budget since both principal amount and interest rate are known.

Disadvantages:

Loan repayments may be used for working capital and cause cash inflow issues ultimately affecting growth.

  • Flexibility with regard to repayment time is mostly non-existent.
  • Too much of debt may cause your business to be identified as high risk entity and hence negatively affecting prospects of raising additional capital in the future.
  • Your business may become vulnerable if your cash flow is affected owing to several reasons, such as drop in sales. This is especially true for new businesses
  • You may have to provide assets of the business as security or collateral.

Equity financing

Equity financing is when an investor finances your business in exchange for ownership of shares or stakes in the business. The investing entity reclaims the investment from future profits. The advantages and disadvantages of equity financing are as follows:

The positives

  • You don’t have to repay the money and hence it is less risky than a loan.
  • You can access the investor’s network, adding more credibility to your business.
  • Your working capital is not affected due to loan repayment compulsions and business growth gets a boost.
  • In case the business fails, you don’t have to repay the investment.

Disadvantages

  • Loss of autonomy since the investor has certain control over the functioning of your business and also shares your profit.
  • You will have to consult the investor while taking decision, which may result in disagreements and friction
  • At times the returns taken by the investor may outstrip interest rates payable on loans.
  • Finding an appropriate investor is both time and resource consuming.

The Final Call

Both forms are essential financing tools for a business and the decision as to which tool to make use of depends on the long-term business goals and the amount of autonomy or control that you wish to retain over your business. Ideally a business needs to use both the tools according to specific situation and needs. It is usually argued that new business may be in a better position if it goes for equity financing and then gradually also includes debt financing to its portfolio. As per experts, an ideal debt-to-equity ratio for a business should be between1:1 to 1:2.