Finding out you need a life insurance policy to fund your SBA loan can be shocking, and trying to navigate the different insurance options can be confusing.
But it doesn’t have to be.
Getting life insurance for a Small Business Administration loan can be super fast and very easy, depending on the type of life insurance product you choose.Here’s the breakdown of why you need life insurance for your SBA loan, how the entire process works, and how to get covered fast.
Yes, You Need Life Insurance for SBA Loans
You probably already know that the SBA does not actually fund any of its loans. They work side by side with a network of banks and other lenders (that they have vetted and approved) who will lend money to your business.
What the SBA does in return is guarantees your loan by backing a portion of your loan if you were to default on the loan. This means that there is less risk for the lender to loan money to you for your business, making it easier for small businesses to get funding in general.
However, the SBA still needs to protect the portion of the loan they would be responsible for paying back.Therefore, they put together some guidelines to protect themselves with life insurance and under the SBA SOP 50 10 5 (b) Part D (pdf), it states:
Lender Must Determine Viability
“Lender must determine if the viability of the business is tied to an individual or individuals. In these situations, the lender must require life insurance.”
Since the most significant percentage of people applying for SBA loans are individual entrepreneurs, this is almost always true. The viability of the business will be tied to you and therefore require you to purchase life insurance.
Your Life Insurance Must Match the Loan
Life insurance required must be consistent with the size and term of the loan. The amount and type of collateral available to repay the loan in the event of the death of the borrower may be factored into the determination of the appropriate amount of life insurance.
So, if you get a $500,000 loan with a 12-year term, you need to purchase a $500,000+ life insurance policy for 15 years or more.
Lender Must Obtain Collateral Assignment
For each policy required under this paragraph, lender must obtain a collateral assignment, identifying the lender as assignee, which is acknowledged by the home office of the insurer. The lender must assure that the borrower pays the premiums on the policy.
So, not only will the lender need collateral assignment on your small business loan through the SBA, but they will also need to make sure you pay your premiums.
Lenders Can Accept Existing Life Insurance
The lender may accept the pledge of an existing life insurance policy. This part of the requirements is very vague, but if you have an existing life insurance policy, that matches the needs of the loan, it can be used as well. Obviously, outside of getting the best rate for your SBA loan, obtaining life insurance is going to be one of the most critical steps in your loan journey.
Now, let’s talk about what requirements your insurance policy will need to meet.
Requirements of Your SBA Life Insurance
“Life insurance and/or disability insurance is not required for all loans, but the Lender should require life or disability insurance where there is a concern over whether the business could survive in the absence of an individual or small group of individuals that provide the management for the small business concern.“
This is just another document showing that if the survival of the business is dependent on just a person or individuals, life insurance is needed. Below we discuss what factors your life insurance policy needs to meet to satisfy the loan:
Policy Must Be In-Force
You must have an in-force insurance policy on yourself. This means you can’t push back the start date of the plan; your life policy has to be active before the loan is funded.
You Must Have Enough Coverage
The death benefit on your policy must cover the total amount of the loan you applied for and continue to cover it for the length of the loan. Mostly, you can’t let the policy lapse.
Your Coverage Has to Last Just as Long
The length of your policy needs to match or exceed the required repayment term length. This is what makes term life insurance the best option; you get to choose your term length to match your loan terms very closely.
Collateral Assignment Must Be Documented
Having a proper collateral assignment will be essential to getting your loan approval, and you must have it properly documented. If your life insurance coverage doesn’t match the above guidelines, you will not be able to get approved for your loan.
You’ve likely seen the words “collateral assignment” mentioned a few times, so let’s discuss it.
What’s a Life Insurance Collateral Assignment?
When you give your lender collateral assignment on your life insurance policy, you are making them the primary financial recipient of the policy.
So, before the life insurance policy pays out to your beneficiaries, it will pay the entirety of the loan first, and then any remaining funds would go to your beneficiaries.That is why it makes good sense to purchase a separate policy, even if you already have a life insurance policy that meets the terms of the loan.
You don’t want to pass away and only leave enough to cover the loan for your business.
For example, say you took out an SBA loan for $350,000 and purchased some term life coverage for $350,000 with the collateral assignment attached. Say you paid off $100,000 of the loan and then passed away unexpectedly.
The policy would pay the remaining $250.000 to the lender and then pay the leftover $100,000 to your beneficiaries starting with the primary beneficiary. Usually, once your life insurance policy is approved, you can request a collateral assignment form from your insurance company.
It is important that you make sure the lender is NOT listed as a beneficiary because this would mean that they get the entirety of the policy.
Setting Up Collateral Assignment for a Small Business Loan
Before you buy any life insurance, you need to be sure they will allow you to do a collateral assignment. Once your policy has been approved, you need to immediately request a collateral assignment from your insurance company or through an insurance agent.
When the policy goes in-force, you need to submit the collateral assignment letter to the insurance company. Once that is done, the insurance company will usually send out a copy of the accepted collateral assignment form to the lender. This process can take some time, so it’s best that you look into something like accelerated life insurance so that you can get covered fast.
How Long Should I Keep the Life Insurance?
To keep the terms of your loan agreement satisfied, you must keep the policy for at least the full duration of the loan. If you let the policy lapse or cancel the policy before you have paid back your loan the lender can find you in default. If you are found in default on the loan they can request that the remaining balance be paid in full.
But, here’s the thing:
There is no reason to cancel a perfectly good life insurance policy. Once you pay back the loan, it essentially turns into a standard life insurance policy that will protect your family if you pass away. It may be in your interest to seek coverage for 10 or more years longer than your loan requires and keep the policy in-force no matter if the loan has been paid back or not.
Just remember, you aren’t locked into any type of contract the life insurance company, and you can cancel this policy when the loan has been paid off.
If I Already Have a Life Insurance Policy, Can I Use It?
According to the SBA, they can accept life insurance policies that are already in-force that meet the terms of the loan. However, you my want to caution against this, especially if you only have one insurance policy.
You would be putting your family’s financial future at risk because you will have to assign the policy to the lender until the loan is paid back. It’s a much smarter option to purchase a new policy.
What if I Have Medical Issues?
You can still qualify for a traditional life insurance policy if you have some medical issues. Only when you get to things more complicated like diabetes with a history of uncontrolled high blood pressure will things get a bit tricky.
The best suggestion is to work directly with an agent who can find the best insurance company for your specific situation. An agent can shop your information around to multiple companies and help you find the best rate when you have medical issues. Moreover, the best thing about it is that it’s a free service; the insurance companies pay insurance agents.
Should I Still Get A Key Man Life Insurance Policy?
If you have other people, who have invested in your company outside of the SBA you probably should have a key man life insurance policy on you.
Quick Overview On How Key Person Insurance Works
If you are an employee at a company or a founder of a business and the survival of that business is based on your survival, you are a Key Person or Key Man.
Usually, the company or investors will purchase a life insurance policy on your behalf, cover the cost of the premiums, and be the primary beneficiary of the policy. If you were to pass away, your company or investors could use the funds to pay back investors or to find a replacement.
An excellent example of this is illustrated by a question asked by Kevin O’Leary, one of the investors on NBC’s “Shark Tank”. He often asks: “What happens to my money if you go out and get crushed like a bug?”
While perhaps shrewd, it is a question that anyone investing in your business should ask, and the honest answer is that they should have a key-man life policy on you.
Disability Insurance Can Be Required As Well
The most under-appreciated type of insurance for a small business owner is disability insurance, or what could be called paycheck insurance.
It’s a fact that illness, not accidents, are the number one cause of disability and becoming disabled as a small business owner could ruin your business. You wouldn’t be able to pay on your small business loan, you wouldn’t be able to keep the life insurance in-force, your rent money would be gone, and you would start burning through your savings fast.
Most people might overlook this part, but it clearly states that both life insurance and disability insurance can be required to be approved for the loan.
Regardless if you are required to purchase disability insurance or not, It’s a good idea to buy a long term disability policy with at least a 5-year benefit period.
A policy like this would make sure you have at least 60% of your annual income being paid out to you monthly for 5 years. While most places won’t require it, it’s irresponsible as a small business owner, entrepreneur, or freelancer, not to have it.
How Fast Can I Get Covered?
If you are reading this, you probably are quickly approaching the deadline for securing your SBA loan. If you have good to average health, some no exam life insurance companies can have you covered in under 5 minutes or less.
They are fully underwritten life insurance policies that don’t require a medical exam, and most of them do what is known as accelerated or real-time underwriting.
The way it works is that the application will ask you specific questions based on how you answered the previous one. It will pull your necessary information from a few databases, matched them with your responses, and give you an answer. On the other hand, if you have a more complicated medical history, you could be looking at around 2 to 4 weeks to get an answer.
It takes longer because you might have to complete an exam or medical records from your doctor may be required. No medical exam policies are going up to $1,000,000 in coverage so if you need more than that, and you probably will have to go the fully underwritten route as well.
Again, if you have to go the traditional route, you can expect a few weeks to get covered.
If you want to fund your loan, you are going to need life insurance for your SBA loan, so there is no reason to wait around. There are far too many other things to focus on when trying to close on a loan from the SBA so you shouldn’t let something as simple as a life insurance policy hold you up.
It’s time to take care of this right now and remove it from your checklist.
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