In today’s Financial Post section on Small Business there is a comment by Tony Wanless who decries the recent demise of the 40 year mortgage. In a nutshell, Mr. Wanless’ position is that the 40 year mortgage allowed for flexible financing because entrepreneurs could obtain a mortgage at lower rates with lower payment that could be made during the “lean” months and then could make higher payments during the good months.
Perhaps. I have two difficulties with the use of mortgages to support your business. The first is that, as a legal matter, you may not be able to make higher payments. The terms of your mortgage may state that either you are not allowed to make any “pre-payments” or else can only make pre-payments up to a specified amount per year. As such, your ability to make the higher payments during the good times may be limited.
The second difficulty is that obtaining financing via mortgages on your personal home is less than optimal. For example, I personally have a line of credit that is used for my law firm. More importantly, though, is the fact that my line of credit is unsecured. If I default on the line of credit the bank cannot go after any specific assets. I have some flexibility to deal with the bank on the repayment terms. I do not have to worry about the added pressure of “losing the house” and my family going out on the street. If my business’ line of credit had been secured with a mortgage, this would become an added worry in a time of already significant stress if my business is failing.
Just as I advise my clients to try their best to avoid giving personal guarantees on business loans, it is always best to try and avoid financing your business through mortgages on your personal home. While I fully appreciate that the 40 year mortgage made life easier for entrepreneurs to finance their businesses through mortgages on their homes and that this is no longer easy, it seems to me that the more important question is whether you should be raising financing for your business this way at all. From a legal standpoint, you should be looking at ways to reduce your personal liabilities for the business - for example, incorporating your business – rather than increasing them, which is what you are doing if you give a mortgage over your home.
In some instances this may be the only way of financing the business. If that is the case, you should seriously consider whether the reward potential outweighs the definite liability risk.