The credit crunch and small business

Entrepreneurs who use home equity for capital may no longer be able to get funding.

By Ian Mount, FSB Contributor

(FSB Magazine) -- When Diane Dobry incorporated Kristof Wines in May 2006 to import brands from Hungary, she did what many first-time entrepreneurs do - she scrounged for capital wherever she could find it, including in her home's equity. She took a $10,000 personal loan, got $13,000 from micro-lender Acción International and tapped a relative for $10,000. But she counted on getting the biggest chunk - $50,000 - from selling the Bethpage, N.Y. house she had bought for $43,000 in 1980.

In July she had a buyer, for more than $400,000, and was making plans to use the money to rev up the business this fall. But before they could close the deal, the mortgage market tightened and the buyers, who were pre-approved, are still waiting for a written commitment.


Dobry, 50, the great-granddaughter of Hungarian immigrants, sees her dream evaporating. "If I don't get it soon I don't know how I'm going to finance my business," says Dobry. "Now's time to order wines for the holiday season. This is when wine stores and restaurants buy."

Dobry is one of an uncounted mass of small-business owners and business launchers who are caught - directly or indirectly - in the collapse of the subprime mortgage market. While overextended home buyers with subprime mortgages have dominated news coverage, thousands of business owners who counted on mortgage financing - many of them young and minority entrepreneurs - suddenly have no place to turn for capital.

A recent Middle Tennessee State University study found that 18.8% of small businesses in the state used home equity loans for startup capital; an August Discover Small Business Watch survey said that 30% had used home-based loans for funding. In the Tennessee study, home equity loans accounted for an average of 43.1% of startup funding for businesses that used them.

Now, that seed capital may be impossible to get. Just a few months ago, lenders would offer up to 95% of a home's value to borrowers with credit scores as low as 600, says Scott Yonehiro, senior board member of First Security Lending, a Burbank, Calif. mortgage company. Suddenly lenders expect scores of 700 and will only loan up to 80% of a house's value. "It will be this way for quite a few years until the market gets lenient with its borrowers again," says Yonehiro.

Brett Carter, the 37-year-old owner of a Denver auto lube shop, is feeling the pinch. After taking a second mortgage two years ago and using some of the money to buy a new $10,000 lift for his shop, Carter had planned to consolidate his two mortgages this year - until the bottom fell out. Carter, who has a home debt/equity ratio of around 93%, was about to sign for a consolidating loan when he got call from his mortgage broker on Aug. 3, telling him about the demise of American Home Mortgage, an aggressive underwriter of "Alt-A" loans, which do not require income verification. That day, his bank pulled his mortgage offer. Now, because he couldn't refinance, his first mortgage (an adjustable loan) has gone from $1,188 to $1,529 a month.

As he notes, the money has to come from somewhere - and that means any expansion plans are now on hold. "It tightens up the belt quite a bit. If I have to pull more money out of the company to live, that means I have to pull money from increasing salaries, from having money saved like a good business should," he says. "It affects everything, from whether we want to expand or put in another piece of equipment to whether we want to hire another customer service representative."

The sight of young companies being stunted because their best sources of capital - home equity financing and credit-card debt - are drying up, has some small business experts calling for better alternatives to encourage new business formation. The Small Business Majority (, a Sausalito, Calif.-based small business association, advocates forming a kind of government-supported venture investing system that would provide funding based on the viability of a new or young business, similar to the micro-lending programs used in developing nations. "Until that happens, small businesses will be dependent on credit cards or homes," says Small Business Majority CEO John Arensmeyer. And, he adds, if you depend on those sources of credit in this environment, you may not be able to launch a business at all.

For Dobry, it's not that dire - she can keep the business going as a part-time pastime, while she continues to work as a university public relations director. "If I don't sell the house I have to keep coming up with money on my own and continue working," she says. "If I do, it allows me to dedicate myself to the business and I can hire more people. And that gives it a better chance of success." Top of page