Wednesday, June 10, 2009

Home Equity Distress Hurting Small Businesses

Many small business owners have had a rough time during this recession. Not only do they face lower sales but home equity loans, that were once a crutch against cash shortfalls, have become increasingly difficult to come by. Tim Iacono from The Mess That Greenspan Made discusses how falling home values have forced small business owners to seek alternative routes for funding.

Of all the dumb things that people did with their home equity money a few years ago when the housing bubble was fully inflated, buying a Hummer H2 was, by far, the dumbest.

Spectacularly stupid home renovations (like adding a separate room to your house for your cat) would probably come in second and big screen TVs, elective surgery, and lavish vacations would be a bit further down the list.

But, some of the more interesting uses for the money "extracted" via home equity loans, from a historical perspective at least, were those individuals who used these funds to start businesses.

Naturally, if you borrowed against your house at the peak of the housing bubble to start up a home improvement business, that decision probably hasn't panned out all that well given the dearth of new granite countertop installations these days but, if, for example, you always wanted to ditch the cubicle life and run a used book store, then maybe that decision would have met with some degree of success.

What's funny about this now bygone era, what was surely a "once-in-a-lifetime business funding opportunity", is that it was exactly opposite the time honored relationship between small businesses and home equity going back decades.

It used to be that borrowing against your home was not only uncommon, but a clear sign of distress in one's personal finances, as in "Poor Ted and Alice down the street had to take out a second mortgage to keep their business afloat".

Earlier in this decade, people sat around, perplexed, trying to decide what to do with all that home equity that was just sitting there, waiting to be "tapped" as homeowners were constantly reminded by the likes of Citibank, and many of those who didn't see the point in buying a hideous gas guzzler or adding a wing on to their house took the plunge and struck out on their own.

Running your own business is, after all, the American dream.

But, as they are finding out today, running a small business is tough during a recession, a point that is made clear in this LA Times story about a number of individuals in Southern California, including the Arnolds below, who have made some major lifestyle adjustments recently.

In better economic times, Santa Clarita mortgage broker Fred Arnold relied on a home equity line of credit if his cash flow was uneven and he needed to cover payroll.

But when home sales crumbled last fall, there was no such backstop for the business. His home was still worth more than the mortgage, but his bank was retrenching and had shut down the credit line. So Arnold sold his house, used some of the proceeds to keep his business afloat and bought a smaller home.

"I thought about cashing out my retirement money and the college savings for the kids, but that wasn't the way to go," Arnold said.

He and his wife are happy in the smaller home, Arnold added, and his home loan business is on more solid ground, thanks to a recent wave of refinancings.

It seems that the Arnolds are the exception to the rule when it comes to home equity financing of small business operations these days and the piece goes on to talk about a wave of small business failures as a result of declining home prices and tighter lending standards.

This is yet one more striking example of how radically things have changed in the U.S. over that last few decades when it comes to the public's attitude toward debt.

Instead of home equity being an infrequently tapped source of funds to "rescue" small businesses during economic downturns, it has now become a source of small business distress as owners had come to rely on this funding for the the normal conduct of business, a source of funds that was anything but guaranteed.

Digging out from the easy-money era takes new twists and turns almost every day.

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