The Effect of Falling Home Prices on Small Business Borrowing

By Schweitzer, Mark E.; Shane, Scott A. | Economic Commentary (Cleveland), December 2, 2010 | Go to article overview

The Effect of Falling Home Prices on Small Business Borrowing


Schweitzer, Mark E., Shane, Scott A., Economic Commentary (Cleveland)


Small businesses continue to report problems obtaining the financing they need. Because small business owners may rely heavily on the value of their homes to finance their businesses (through mortgages or home equity lines), the fall in housing prices might be one of the causes of their difficulty. We analyze information from a variety of sources and find that homes do constitute a significant source of capital for small business owners and that the impact of the recent decline in housing prices is significant enough to be a real constraint on small business finances.

A persistent issue throughout the recovery has been the reported inability of small businesses to get the financing that they need. To better understand the sources of any shortfall, the Federal Reserve System undertook a project in 2010 to meet with representatives from banks and small businesses.1 In some of the focus groups convened by the Federal Reserve this summer, participating small business owners explained that the reduced value of their homes has made it difficult for them to provide the necessary collateral for small business loans. Other participants said that the reduced value of homes has made home equity borrowing as a source of business capital more difficult to come by, also contributing to the difficulty many small businesses face in obtaining sufficient capital to finance their operations. While the small business owners' message of a link between home values and small business borrowing came through loud and clear in the focus groups, the process did not provide estimates on the magnitude of the effect of declining home values on small businesses' access to capital.

Data sources on the full range of small business finance options are rare, and they often cover only a portion of small businesses. In part, this is because small businesses are by nature highly heterogeneous, ranging from relatively large and financially sophisticated car dealerships to single-person startups structured as sole proprietorships. Despite this variation, the focus groups revealed financial challenges for both the largest and smallest of small businesses.

This Commentary analyzes information from a variety of sources in order to quantify the connection between home values and small businesses' access to capital. Specifically, we examine the extent to which small business owners use their homes to finance their businesses, the rise in the use of homes as a source of capital for small businesses during the housing boom, the magnitude of the effect of housing price declines on small business finance, and the variation in these issues across states, industries, and types of small businesses. Our analysis reveals that the magnitude of the effect of home prices on small business finances is large enough to be a real constraint on growth but the degree to which home price declines are hindering the growth of small businesses is difficult to fully quantify. Differences across the data sources and the heterogeneity of small businesses continue to limit what we can determine.

Do Small Business Owners Use Residential Mortgages to Finance Their Businesses?

Small businesses owners often report using residential real estate to obtain capital for their businesses. One set of estimates on the extent of such financing comes from a 2009 Gallup survey of small business owners funded by the National Federation of Independent Businesses (NFIB). The sample was designed to be representative of all firms with fewer than 500 employees, the Small Business Administration's definition of a small business. Approximately 16 percent of those surveyed reported that they borrow against the value of their homes for business purposes, and 7 percent said that they put up their homes as collateral for business purposes. These numbers rise to 20 percent and 11 percent, respectively, if one includes residential real estate other than the owner's primary residence. …

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