In better economic times, Santa Clarita mortgage broker Fred Arnold relied on a home equity line of credit if his cash flow was uneven and he needed to cover payroll.

But when home sales crumbled last fall, there was no such backstop for the business. His home was still worth more than the mortgage, but his bank was retrenching and had shut down the credit line. So Arnold sold his house, used some of the proceeds to keep his business afloat and bought a smaller home.

“I thought about cashing out my retirement money and the college savings for the kids, but that wasn’t the way to go,” Arnold said.

He and his wife are happy in the smaller home, Arnold added, and his home loan business is on more solid ground, thanks to a recent wave of refinancings.


That makes Arnold, president of the California Assn. of Mortgage Brokers, a lucky guy compared with hosts of small-business owners who relied on their housing wealth to start companies, buy equipment and manage payrolls. No longer buoyed by the housing boom, many now find their businesses and homes sinking in the backwash from the easy-money era.

Even in the best of times, bank financing has not been easy to find for owners of start-ups, who instead typically rely on “the three Fs -- family, friends and fools,” as Alton W. Do of the Oakland Business Development Corp. puts it.

No wonder, then, that using home equity credit lines and cash-out refinancings for business purposes was widespread during the good times. After all, 95% of small-business owners also own their own homes, according to a survey late last year by the National Federation of Independent Business.

To get cash for business expenses, one-third of California small-business owners took out exotic, high-risk products, such as those that required little proof of income or allowed borrowers to pay so little that their loan balances rose, said accounting Professor Samuel D. Bornstein of Kean University of Union, N.J.


Bornstein, who has studied the issue extensively, predicts the business owners, many now far underwater on their loans, could shed 2.1 million jobs in the state over the next four years, creating even more problems than the initial wave of subprime mortgages.

“The second tsunami is particularly going to inundate small businesses,” Bornstein said.

In Southern California, many immigrants refinanced their homes to start such enterprises as food deliveries to restaurants and home remodeling services, said Namoch Sokhom, director of business development for the nonprofit Pacific Asian Consortium in Employment in downtown Los Angeles and El Monte.

These people, many with limited English skills, had no financial track records in this country that would allow them to get bank loans, Sokhom said. Instead, lenders advised them to raise capital by refinancing with adjustable-rate mortgages or using home equity credit lines, he said.


The idea of using a house to finance a business caught on in the ethnic communities, said Sokhom, 60% of whose clients are immigrants from Asia or Latin America.

“People were saying that if you don’t do it you are crazy, you don’t know what’s going on,” he said. “And they said if you can’t pay when the loan resets, you just refinance again.”

What Sokhom calls the “foreclosure crisis” among his clients started last year, when gasoline prices shot up.

“Many of them came to us and said, ‘We cannot do any more deliveries because every trip out we lose money.’ Many of these people, when they bought a truck, used their home equity or an equity loan outright to buy the truck,” Sokhom said. “Now when the business goes sour, they cannot pay the mortgage also.”


Others, like mortgage broker Arnold, have had their home equity credit lines cut off because of falling housing prices. For people in the home improvement business, that has meant no access to funds to buy materials and pay workers until the job is complete and they are paid, Sokhom said.

The evaporation of mortgage-related credit is part of a broader pullback by lenders in the recession.

Businesses that had counted on bank financing have been finding it harder to get. The Federal Reserve reported last month that U.S. banks had tightened their standards for lending to small businesses for 10 consecutive quarters.

The trend intensified throughout last year, peaking in the fourth quarter, when 74.6% of senior lending officers in a Fed survey reported making it more difficult for small businesses to obtain credit to fund payrolls, buy equipment and finance other operational needs.


The trend eased slightly in the first quarter of this year, with 69.2% of the lending officers saying their banks had tightened credit for small businesses.

But the lenders also reported that small-business demand for commercial and industrial loans and lines of credit was down sharply as the downturn took its toll and the gross domestic product fell at an annual rate of 6.1%.

No wonder, then, that both small-business owners and the public “remained pessimistic,” as the Small Business Administration said in a recent quarterly report on the economic climate. “Poor sales and access to credit are major issues.”

The National Federation of Independent Business survey found that of the small-business operators who owned homes, 26% had mortgaged the residences to provide capital for the business. Answering a separate question, more than 10% said they had pledged their homes as collateral to buy other business assets.


That’s a far greater number than those who use SBA loans, the government-guaranteed loans made by banks and credit unions.

“Only about 5% of people seeking business loans use SBA,” said Robert A. Borden, an SBA regional spokesman in San Francisco. “The majority use personal funds, borrow from friends and relatives, or use credit cards.”

Those seeking SBA loans usually wind up dependent on their home equity in any case. That’s because the government generally requires that business owners provide collateral to personally guarantee the loans along with the government guarantees.

For most business owners, that means pledging their homes to back the loans, Borden said. If a loan goes into default, the SBA guarantee kicks in only after the bank recovers what losses it can by going after the home or other personal assets.


The SBA, trying to encourage lending, recently dropped some of its fees and increased its guarantees from 75% or 85% of loans to 90%. And a program called SBA Express, which provides lenders with reduced guarantees, allows banks in some circumstances to waive the demand that borrowers post collateral.

But there’s no such thing as easy money these days: As banks tighten the credit spigot, SBA-guaranteed loans are expected to drop to between 75,000 and 80,000 this year from 110,000 last year, a decline of as much as 32%, Borden said.

The requirement to pledge a home or other personal asset to get banks to write SBA loans has put such loans beyond the reach of some otherwise well-established business owners.

A.J. Gilbert, owner of Luna Park restaurants in San Francisco and Los Angeles, said that in the past he managed to get SBA loans for his businesses without providing a personal guarantee.


But when Gilbert went looking recently for financing for a new restaurant, Henry’s Hat, that he is opening on Cahuenga Boulevard near Universal Studios, no bank would lend him money when he told them he didn’t own a home and he wasn’t willing to pledge his personal assets.

In the end, Gilbert obtained about $250,000 in financing through the Valley Economic Development Center, a Los Angeles nonprofit. But that’s not an option for most people because the amount of funds available at such nonprofits is limited. The development center made $6 million in loans last year, up from $4 million the year before but a minuscule amount compared with the demand for small-business financing.

“Most people who want to borrow from a bank for SBA money will put their houses up as collateral,” Gilbert said.

And that’s become a lot harder to do in today’s depressed real estate markets.


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scott.reckard@latimes.com