Personal Financing
"Save a little money each month and at the end of the year you'll be surprised at how little you have." Ernest Haskins

Most small startup business are initially funded by the personal assets of the entrepreneur. Some funding for your small business is likely to come from your direct contributions of personal savings or assets to the business (e.g., an early retirement incentive payout). Additional personal funds are often contributed after the entrepreneur borrows money through a personal (consumer) loan and then contributes that money as an equity investment into the business.

 
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The majority of consumer loans will require that you secure the loan with an equity (ownership interest) in an asset that exceeds the amount of the loan. Unless you have an extremely solid personal credit history with a commercial lender, the institution is unlikely to grant an unsecured loan to a startup business.

There is a great variety of personal assets that you can use as collateral to obtain cash from a lender, but perhaps the most common source is a residence. You can use this asset to: obtain a first or second mortgage, to refinance an existing mortgage, or to secure a home equity loan or line of credit. The major disadvantage to using your house as collateral is that default on the loan can mean forfeiture of your home.

Nearly all commercial banks and residential lending institutions will have options available for home-backed financing. The period and computation of the rate of interest, upfront points, closing costs, administrative costs and burdens, the length of loan, loan conditions, and default terms all affect the real cost of a loan. Whether or not the local lender will sell your mortgage to another creditor may also be a consideration for you.

For second mortgages or lines of credit, you should anticipate that lenders will allow a maximum total mortgage debt, including preexisting mortgages, of approximately 70 percent to 85 percent of the current market value of your residence. Recently, some lenders have begun offering financing up to 100% of your home's current market value, but interest rates are steep, and the risk of losing your home if your business fails make these loans a last-ditch choice for most budding entrepreneurs.

 
Example

If your property is currently valued at $180,000 and you have an existing mortgage of $80,000, your equity value in the house is $100,000. If the lender's maximum loan-to-value percentage is 80 percent, your maximum second mortgage would be for $64,000. The reason for this is that you must continue to maintain at least 20 percent equity in the home ($36,000), leaving $144,000 available to be financed. $144,000 - $80,000 (your existing mortgage) = $64,000.

Also, be aware that second, or even third, mortgages will typically have higher interest rates than first mortgages because the lender is subordinate to a prior mortgagor. (In other words, if you default on the loans, the first-mortgage lender will be paid off first, and the second-mortgage lender may not be paid at all.) In instances where your interest costs would not be significantly increased, you may be better off refinancing the existing mortgage for an increased loan amount rather than taking a second or third mortgage.

 
Did You Know?

In the event real estate is to be used as collateral, borrowers should be aware that banks and other regulated lenders are now required by law to obtain third-party appraisals on real estate-related transactions of $50,000 or more. Certified appraisals are required for loans of $250,000 or more. When commercial real estate represents the major piece of collateral for an loan, the SBA will also require a third-party appraisal.

Other than your residence, other commonly used collateral for secured consumer loans include other real estate, life insurance policies , any existing machinery or other business equipment, stock, and pension plans.

For instance, you can usually borrow the cash surrender value of an ordinary life insurance policy. You are not obligated to repay the loan principal, only to pay interest on the loan. The rate of interest charged depends upon when the policy was purchased; rates on older policies might be very favorable. Of course, borrowing against your own policy means the eventual death benefit of the policy will be diminished by the amount of the loan, plus the loss of interest.

You may also have other assets in your personal portfolio that permit you to borrow from them or that can be used as collateral in a conventional loan. For example, if you have an employee retirement plan, you may be able to borrow against those savings up to a certain percentage of your total plan value. Marketable securities can also be pledged to a bank as collateral for a loan.

 
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If you can qualify for a consumer or home equity loan, you might be better off not disclosing that the purpose for your loan will be a new small business. Conservative lenders may be more skeptical of making a consumer loan if they know that the money will be invested into a startup business.