When you’re applying for alternative financing like an SBA loan, you may need a life insurance policy before your loan can close. Many small business owners are surprised when this requirement comes up, and it can potentially delay your loan application if you’re not ready for it, but it’s an important part of the SBA lending process.
Explore why you’ll need life insurance for SBA loans, what you’ll need to do to meet the requirement, and more.
Why do lenders require life insurance for SBA loans?
Your lender may require you to have life insurance before closing on your loan because it protects everyone involved if you (or a business partner) pass away.
While this is a circumstance that no one wants to imagine, it’s a reality in small business lending. Many small businesses are owned and operated by one owner or partnership. If the sole owner or a business partner passes away, it may mean that the business will no longer be in operation.
Life insurance for SBA loans and other loans not only protects your lender’s interest, it protects your family from taking on your outstanding business loan. Instead, the life insurance policy will pay off the loan.
When do you need life insurance 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) loan typically requires life insurance for the full loan amount. However, in certain cases, the life insurance requirement may be reduced or waived if you’ve pledged significant collateral or have a succession plan in place to continue operations.
- For an SBA 504 loan, life insurance is typically only required if your collateral doesn’t fully cover the loan. In some SBA 504 loan deals, 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 includes your lender as an assignee on the policy.
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 only need to assign $500,000 of their individual life insurance policies. 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 business 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 as soon as you get started with the process. 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 started 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.
If you’ve never applied for a life insurance policy, reach out to your local insurance broker or ask for a referral from other business owners in your network.
Whether it’s a new or existing policy, work with your insurance provider to complete a collateral-assignment agreement before the loan closing.
Life insurance for SBA loans: Extra protection for your lender and your family
The life insurance requirement for SBA loans and other financing options gives you, your lender, and your family an extra layer of financial protection and peace of mind. When you apply for an SBA loan with Pursuit, you’ll have full transparency on what’s required to get to the closing table.
Our expert lending team will answer your questions and keep you updated on what’s next throughout the application process and beyond. Ready to take the next step? Reach out to us to learn more about our small business loan options available to small businesses in New York, New Jersey, Pennsylvania, and Connecticut.
