Building your business? You might need outside funding to reach your goals. There’s no doubt that applying for a loan comes with a lengthy to-do list.
If you’re applying for a Small Business Administration (SBA) loan and plan to stay involved in the day-to-day operations of the company, that could include buying a life insurance policy.
When applicants need life insurance to get an SBA loan
A life insurance policy is required when the business is “tied to an individual or individuals,” under SBA SOP 50 10 5 (B). If you’re an entrepreneur looking to take out an SBA loan to make your business goals a reality, life insurance is a must. The success of the business rests on you, so lenders want to make sure they have collateral in case something happens to you.
The life insurance requirements
Your life insurance policy is there to protect your lender and lower their risk. As such, there are a few guidelines you’ll need to follow when you’re shopping around for a policy:
- The coverage amount should match the size of your business loan. If you pass away before paying off your loan in full, your lender will need to repay the balance on your behalf. So, if you’re applying for a $500,000 loan, aim to take out a life insurance policy worth $500,000. If you die, your life insurance company will pay out $500,000 to your beneficiaries — but more on that in a minute.
- The policy should last as long as your loan, too. Most SBA applicants buy a term life policy, which is the simplest and cheapest type of coverage. These policies last a set period of time — like 10, 15, 20 or 30 years. To boost your chances of getting your loan approved, purchase a policy with a term that reflects how long you plan on taking to pay back your loan. Since you’re essential to your company’s success, the act of taking out coverage on yourself for business purposes is often referred to as “key man insurance.”
- You’ll need to name your lender as the beneficiary — or one of the beneficiaries. The good news is you don’t need to nominate your lender as the sole beneficiary. But they do have to be your primary beneficiary — aka the person who’s first in line to receive the payout. This is known as a life insurance collateral assignment. When you buy a policy, you can assign your lender to receive a payout from your policy equal to the amount that will cover your outstanding balance. The rest of the money will go to your other beneficiaries, such as your spouse or children.
Let’s put this into practice. Say you’re a business owner who purchases a $250,000 life insurance policy to back your $250,000 SBA loan. You ask your life insurance company for a collateral assignment form for your lender and nominate your spouse as a separate beneficiary. Over time, you pay off $100,000 of your loan before dying unexpectedly. Your lender will receive $150,000 to pay off your loan balance, and your spouse will get the remaining $100,000.
If you have loved ones you’d like to leave money to, the collateral assignment is really important. Otherwise, your lender could get the total payout from your policy — even if it exceeds the amount they need to repay your loan.
How to buy a life insurance policy
There are two paths you can go down. You can apply for a traditionally underwritten policy, which can take anywhere from three to eight weeks to approve. As part of the process, you might need to do a phone interview or take a medical exam, which is a basic physical your insurer pays for.
If you’re racing against the clock to secure your loan, you can purchase a term life insurance policy online. There are a bunch of fintech companies that can issue policies instantly, including Bestow, Ethos, and Haven Life. They’re backed by strong parent companies, and you most likely won’t need to take a medical exam. The downside is you can’t customize your coverage with as many riders.
Either way, it’s important to compare life insurance companies and policies to find one that fits your family’s — and your business’ — needs and budget.
About the Author
Katia Iervasi is a staff writer for the insurance team at finder.com. In addition to dozens of mortgage and personal finance pages, Katia has written more than 250 insurance articles that help readers understand the intricacies of policies across life, car, health and more.
Hailing from sunny Sydney, Australia — where she earned a Bachelor of Communication from Griffith University, majoring in journalism and public relations — Katia now calls New York City home. Her goal is to help you splash your cash smartly (and be a pro when the subject pops up at dinner parties).