Why do SBA loan lenders require life insurance?
As a small business owner, you’re likely familiar with SBA loans. SBA loans are loans backed by the United States Small Business Administration and are meant to help fund small businesses. If you’re looking to start or expand on a small business, understanding the life insurance requirements for SBA loans is a great place to start.
Many lenders will require you to have life insurance before closing on your SBA loan because it protects you, the lender, and any business partners you have if you pass away. The life insurance policy will pay off your loan in the event of your death, helping your family and business partner(s) avoid taking on that financial burden. In this article, we’ll help you understand scenarios in which you’ll need to apply for life insurance before getting an SBA loan.
How Life Insurance is Used as Collateral for Businesses
When businesses need financing, they might use life insurance as collateral, either on a key person policy or a permanent life insurance policy the business owns. The lender can place a lien on the policy, which gives them the right to claim the death benefit or cash value if the business defaults on the loan.
Businesses can also pursue collateral assignment, a specific arrangement in which the business assigns its life insurance policy to the lender as collateral for a loan. In the event of default, the lender can access the policy’s death benefit or cash value to repay the debt. The business retains control of the policy but agrees that the lender will be paid first if the policy is accessed.
How much life insurance coverage do I need for an SBA loan?
Coverage requirements for SBA loans will vary based on the type of loan you’re applying for.
An SBA 7(a) loan typically requires life insurance coverage equivalent to the full amount of the loan, but this requirement may be reduced if you’ve offered significant collateral toward your loan. SBA loan collateral can take many different forms, including assets like business or personal real estate, accounts receivable, or inventory.
An SBA 504 loan will only require insurance if your collateral doesn’t fully cover the loan. You may be able to leverage an existing life insurance policy, but the lender may require that the term of the policy matches the life of the loan. For example, if your SBA loan will take 10 years to pay off, you’ll want to make sure your life insurance policy has at least 10 years left on the term. You’ll also want to ensure you have enough coverage if you want to use an existing term life insurance policy for your loan. This means that the policy’s death benefit is enough to cover the loan amount.
Alternatives to SBA Loans
If an SBA loan doesn’t suit your needs, you can consider some of the following alternatives.
Business Line of Credit: A business line of credit works like a credit card, providing access to a pool of funds that can be drawn from as needed. The business only pays interest on the amount borrowed.
Online Lenders: These are non-traditional lenders that operate online and offer various loan products, often with faster application and approval processes than traditional banks.
Personal Loans: A personal loan can be used to fund a business, especially for small startups. The business owner is personally liable for the loan.
Crowdfunding: Crowdfunding platforms, such as GoFundMe, allow businesses to raise funds from a large number of people in exchange for rewards, equity, or debt repayment.
When should you apply for life insurance for your SBA loan?
When it comes to applying for life insurance for an SBA loan, it’s important to be proactive. Here’s what you need to know.
Start Early: You should ask your lender if life insurance is required for your SBA loan early on in the loan application process. Here’s what you need to know about the process:
Ask for Specifics: Make sure to ask for specifics like the coverage amount required and if you’re able to use an existing life insurance policy to qualify for the loan. If you have to apply for a new policy before getting your SBA loan approved, you should do this as soon as possible, because the life insurance application process can take time with steps like screening questions, medical exams, and underwriting.
Consider Ways to Expedite: If you want to expedite this process, you may consider applying for no medical exam life insurance (also known as instant life insurance), which can provide up to $5 million in coverage for those under age 60 and in good health.
Planning to apply for an SBA loan? Let SelectQuote find you the right life insurance policy.
Having the right life insurance policy can help make the SBA loan application process smoother. At SelectQuote, we have over 40 years of experience and can answer any questions you have about SBA loans and life insurance, whether you want to use your current policy, update your coverage, or apply for a new policy altogether. We quickly and easily search trusted carriers, gathering unbiased quotes to help you find the right plan for your needs and budget.
