Life Insurance for SBA Loans: What You Need to Know
When applying for an SBA loan, your lender may require a life insurance policy, before your loan can close. Many small business owners are not aware of this requirement, however, it is an important part of the SBA lending process
Why do Lenders require life insurance for SBA loans?
Lenders may require life insurance before closing on an SBA loan because it protects everyone involved if you pass away. This is a circumstance that no one wants to imagine, it is reality in small business lending. Many small businesses are owned and operated by one owner, or partners. If you or your business partner pass away, it may mean that your business will no longer be in operation.
Life insurance for SBA loans, and other loans not only protects your lender’s interest, it also protects your family from taking on your outstanding business debts. Instead, the life insurance policy will pay of the balance of the loan.
When is life insurance required for an SBA loan?
Every small business loan is different, so there’s no blanket answer for when life insurance will be required for your loan. Here are some general guidelines regarding life insurance for SBA loans to help you get a better sense of this requirement:
- An SBA 7(a) typically requires life insurance for the full loan amount. However, in certain cases, the life insurance requirement may be reduced if you’ve pledged significant collateral.
- For an SBA 504 loan, life insurance is only required if your collateral doesn’t fully cover the loan. In many SBA 504 loan deals though, the property or equipment you’re purchasing with the loan is enough.
Should you use an existing life insurance policy or take out a new one?
If you already have a life insurance policy (and your insurer allows it), you can assign part of your policy as collateral coverage. You could also take out a new policy that assigns your lender as a beneficiary.
With a term life insurance policy, your lender may require that the term of the policy matches the term of the loan to ensure full coverage throughout the life of the loan.
If your business has multiple owners who are active in its operations, then the assignment can be split evenly. For example, if two active owners apply for a $1 million small business loan, then each owner would need to assign $500,000 of the life insurance policy. If you’re the only one that’s active in the business’s operations, then you’ll need to assign the entire $1 million to your lender.
If your business can continue to run even if you (or your partner) pass away, then the life insurance requirement may be waived. This can only be done at the SBA’s or your lender’s discretion.
How to keep your loan process on track when life insurance is required
When you’re applying for a small business loan, ask your lender if life insurance is required. If it is, ask for the specifics, such as the amount that will need to be assigned. You should also:
- Determine whether you’ll use an assignment from an existing policy or take out a new one. Get either process underway right away with an insurer of your choice.
- Reach out to your insurance provider to make sure assigning an existing policy (if you have one) is possible based on information from your lender’s closing attorney.
Setting up a new life insurance policy can take some time, so you should start it early in the application process. Keep in mind that your insurer may require a doctor’s appointment, which can take time to complete (and if multiple owners need appointments, this can take even longer), so give yourself as much time as possible.
Whether it’s a new or existing policy, work with your insurance provider to complete a collateral-assignment agreement before the loan closing.