Who this is for: Owners of established small businesses who have equity in their own home, a clear use for the money, and a repayment plan that does not depend on one good month.
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Banks tend to look at a business loan the way they look at a young company: with caution. Owners who have built equity in their home often discover that the house is easier to lend against than the business. That is how a business purpose second mortgage starts. It is also how a bad year for the business can become a bad year for the family.
What a business purpose second mortgage is
It is an ordinary second mortgage, registered behind your first mortgage, where the money goes into your business rather than the house. The Financial Consumer Agency of Canada describes second mortgages as loans on your home that usually carry higher rates than first mortgages, because the lender takes more risk. The lender sets how much you can borrow from the value of the home and the balance on your first mortgage, not from the company’s sales.
Because the loan is secured on the house, the lender can usually say yes where an unsecured business lender would say no. The price of that yes is that the home guarantees the loan.
When it makes sense
It makes sense when the money has a specific, measurable job. Buying inventory that has a ready buyer, covering a gap between a large invoice and its payment, buying equipment that replaces a clear cost, or funding a contract you have already won are all easier to defend than general working capital.
It also suits a business with good prospects and a short-term problem, such as a seasonal dip or a delayed payment. If you can point to the date the cash returns, the loan has an exit.
Owners with irregular income on paper sometimes qualify for a home equity loan more easily than for a business loan, because the lender looks at the property first. That can help, but it is not a reason to borrow more than the business can repay.
When it makes things worse
It makes things worse when the loan covers a loss that has no end in sight. Using a home loan to pay rent, payroll and suppliers for a business that is not turning a profit only buys time, and the time costs interest and fees. When the money runs out the business has the same problem and your house is carrying the debt.
It also makes things worse when the business is tied to the same household. If your income and the family’s housing both depend on the one company, a bad stretch hits both at once. Think about what you would do if the business paid you nothing for six months.
Be careful about personal guarantees and cross-collateral as well. A lender or a supplier may ask you to guarantee another debt, and you should know how all of them connect before adding a mortgage to the list.
What it really costs
The first worked example above shows a $75,000 loan costing $13,500 for one year, which is 18% of the amount before any other business cost. The money has to earn more than that, in profit, after all its other costs, or the loan has taken more than it gave.
The Financial Consumer Agency of Canada lists appraisal, title search, title insurance and legal fees among the costs of borrowing against equity. Add the lender fee and, if a broker arranged the loan, the broker fee. Ask for the total in dollars. Use the calculator to check a quote, and then compare it with the margin your business really earns on that spending.
The second example looks at tax. The Canada Revenue Agency’s interest folio says the use of the borrowed money must be established, that the purpose of the use must be to earn income, and that the borrower has to trace the money to an eligible use. Money used for personal purposes does not qualify. A deduction can soften the cost, but it depends on your facts, so ask an accountant before relying on it.
The risk to your home
The home is the security. If the business cannot pay, the lender still has a claim on the house, and the agency warns of serious consequences including foreclosure when a home equity loan cannot be repaid. That risk does not shrink because the money was spent on something that looked sensible at the time.
A second risk is the stack. A business purpose loan can sit alongside a first mortgage, a business loan and a line of credit. Add them up and see what is owed against what you own, and what happens to each if sales fall by a third.
Keep paying the first mortgage on time, whatever the business is doing. A missed first mortgage payment can lead to legal action that affects every lender on the title.
Options to try first
Ask your own bank for a business loan, a business line of credit, or an equipment loan that is secured on the equipment itself. Look at invoice financing for receivables, supplier terms, and government-backed small business loan programs that your bank can explain. These keep the family home out of the deal, and they are often cheaper.
If your business is new, consider whether a smaller amount of borrowing, a slower start or an investor would let you avoid pledging the house. A personal line of credit may be an option too, though it also puts your personal credit at risk.
If you are self-employed and the main problem is that banks do not count your income, the page on self-employed second mortgages covers that case.
How the exit works
A business purpose loan is usually short. At the end of the term the full balance is due. Before you sign, write down where that money comes from: business profit, a refinance of the house with a bank, the sale of an asset, or a new loan for the business. A refinance depends on your credit and your tax returns at that time, so build the plan around a bad year, not a good one.
Ask what it costs to extend, and what the lender does if you are a few weeks late. Both answers should be in writing.
What to ask before you sign
- The total cost of borrowing in dollars for the full term, with every fee shown.
- What you will still owe on the last day.
- Whether the lender limits what the money can be used for.
- What it costs to extend or renew.
- Whether any personal guarantees or other security are required.
- The name of the licensed professional and how to check their licence with your provincial regulator.
Talk to your accountant about the tax treatment before you borrow, not after. If you want to speak with a licensed mortgage professional in your province, you can check your options. You are free to say no.
A $75,000 inventory purchase held for one year
Made-up figures only. An assumed 12% interest-only rate for one year, with an assumed 2% lender fee, 1% broker fee and $2,250 for legal, appraisal and title.
- Interest for one year
- $9,000
- Lender fee
- $1,500
- Broker fee
- $750
- Legal, appraisal and title
- $2,250
- Cost to borrow for one year
- $13,500
$75,000 at 12%
2% of $75,000
1% of $75,000
What the interest might cost after tax if it qualifies as a deduction
Made-up figures. The $9,000 of interest is assumed to be fully deductible and the owner's assumed combined tax rate is 25%. Fees are left out because their tax treatment differs. Your accountant decides what applies.
- Interest for the year
- $9,000
- Assumed combined tax rate
- 25%
- Assumed tax saved at 25%
- $2,250
- Interest cost after the assumed saving
- $6,750
$9,000 x 0.25
Questions people ask
Why would a lender give a business loan against my house?
The house gives the lender something to rely on that a young or uneven business may not. They look at the equity, the first mortgage and the exit plan more than the company's statements. That is also why the loan puts your home on the line for the business.
Can I deduct the interest on a business purpose second mortgage?
Possibly. The Canada Revenue Agency's folio says interest on borrowed money is generally deductible only when the money is traced to a use that earns income, and personal use does not qualify. Keep records and ask your accountant before you assume anything.
What if I use part of the money personally?
Mixing business and personal use makes the tax treatment harder to defend. The folio puts the burden on the borrower to link borrowed money to an eligible use. Keep the funds in a separate account and pay business costs from it so the trail is clear.
Does the lender care what the business does?
Often yes. Some lenders limit the purposes they will fund, and some will not lend for certain industries or for speculative ventures. Tell the licensed professional exactly what the money is for at the start, because the stated purpose goes into the commitment.
Is a business purpose loan the same as a business line of credit?
No. A business line of credit is secured by the business or by your guarantee, while this loan is registered against your home. The home is at risk if payments stop, and the terms are those of a mortgage, including the due date at the end of the term.
What if the business fails before the loan is repaid?
The loan still has to be repaid, and it is secured against your home. Talk to the lender early, and speak to a Licensed Insolvency Trustee if the business and the loan are both out of reach. Do not wait until a legal notice arrives.