Declining Home Values Hurting Small Businesses

December 29 2010 (Jeff Alan)
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A recent study by the Federal Reserve helps to answer one of the reasons why small business creation has been lagging since the end of the recession. The study found that declining home values has limited the ability of homeowners to borrow against the equity of their property which has been an important source of capital in the past.

The Federal Reserve Bank of Cleveland noted that while tighter credit and reduced demand are often cited as reasons that small business lending has declined during the recession, falling property values are also a significant factor and one that could prove harder to overcome.

“The decline in home values has constrained the ability of small business owners to obtain the credit they need to finance their businesses.”

Small business owners reported last summer, that the reduced value of their homes made it difficult for them to obtain the capital needed to finance their business. According to one study cited, as many as one in four small business owners in 2007 either used their home as collateral for a business loan or took out a personal home equity loan to provide business capital.

The report found that households headed by small business owners used Home Equity Lines of Credit (HELOCs) more extensively than those headed by non-business owners. In addition, small business owners’ use of HELOCs increased more rapidly during the housing boom, suggesting they were tapping into more equity.

Certain types of businesses, particularly those in the real estate and construction industries, younger and smaller businesses, those with uncertain financial prospects and those in states where the increase in home values during the boom was highest appeared to more likely to borrow against their homes equity.

Although the more widely recognized business credit concerns may dominate the press, restoring home equity lending for the purpose starting a business or expanding a business presents significant challenges in today’s housing market.

“Returning small business owners to pre-recession levels of credit access will require an increase in home prices or a weaning of small business owners from the use of home equity as a source of financing. Neither of those alternatives falls into the category of easy and quick solutions.”

Tags: home values, federal reserve, recession, homeowner equity, tight credit, small business lending, falling home values, small business owners, heloc