Home equity loans create a bump in entrepreneurship rates

Terry College economists tie rise of small businesses in Texas to home equity loan access
still life of a model house

The home has long been a great store of wealth for most American families, and new University of Georgia research ties this access to greater entrepreneurial outcomes.

Terry College of Business economists William Lastrapes and Ian Schmutte focused on a 1997 change in Texas law allowing homeowners to use home equity loans to start businesses or provide supplemental credit to existing businesses. They found new business creation increased by about 3.5 percent because of the law change, and business dissolutions shrank by about 1.7 percent. Furthermore, these effects were concentrated among small businesses.

Their paper “Home Equity Lending, Credit Constraints and Small Business in the US” appeared in the January 2022 edition of Economic Inquiry.

“It certainly suggests that making credit more readily available leads to greater entry of small businesses and slower rates for deaths of those businesses,” Schmutte said. “We know that small businesses and especially young businesses are engines of the economy, so that’s something that policymakers continue to focus on quite a bit.”

Texas was the last state to legalize home equity loans for business use. This provided a perfect test environment for what happens when home equity is suddenly available as loan collateral to small business owners.

Aimed at protecting homesteads from predatory lending, the prohibition against using home equity loans for businesses was included in the Texas Constitution when ratified in 1876. Voters changed the state’s lending regulations through referendum in 1997.

Many economists saw the sudden change of credit availability in Texas as a natural experiment. But Schmutte and Lastrapes relied on controlled-access U.S. Census microdata and publicly available U.S. Census, IRS and Bureau of Labor Statistics data to conduct their analysis.

The data allowed them to estimate the number of small businesses created in the decade after the change, identify the types of businesses that benefitted, and construct a measure of “small business dynamism” — the rate at which new businesses begin and workers move from one job to another to meet labor demands. An increasing rate of small business dynamism is a sign of a growing or healthy economy.

Their analysis found that while the change in Texas law benefitted all small businesses, those with 10 or fewer employees benefitted the most. These small business owners have the least access to traditional small business loans but are the economic engines of the U.S. economy, making up three-quarters of businesses nationwide.

“The kind of business that’s going to have a ton of employees, even 50 employees — they’re going to have access to other kinds of funding in general,” Schmutte said. “So this type of home equity is not going to be important for them. We’re talking about small restauranteurs or maybe those who are engaged in some sort of small manufacturing operation. The businesses that seem to be affected by this are almost exclusively small.”

The decline in small business dissolutions points to the utility of home equity loans, allowing business owners to “smooth out the bad times” instead of closing up shop or laying off employees, Schmutte said. Borrowing against home equity seems to serve as a hedge against sudden demand shocks or operational changes.

That’s one reason this decades-old natural experiment still applies today, Lastrapes said.

“Availability of credit has been a key policy concern during the COVID‐19 pandemic of 2020 and 2021,” Lastrapes said. “Our results confirm other studies suggesting that constraints on borrowing matter a lot for the viability of small and young businesses. The data from Texas show that availability of credit to small businesses really does increase their likelihood of survival.”

In this paper, Lastrapes and Schmutte did not look at whether access to home equity loans for businesses affected the rates of entrepreneurship among marginalized groups, but Schmutte suggested that could be a topic for future research