Life Insurance for SBA Loans: The Ultimate Guide

Life Insurance For SBA Loans

Life Insurance for SBA Loans: The Ultimate Guide

Ready to transform your business ideas into reality? Like most entrepreneurs, you likely need an SBA loan to help fund your new enterprise. But you might be surprised to learn that you first need a life insurance policy to get approved.

Obtaining the right life insurance for your SBA loan sounds like a headache. But with clear guidance from a qualified life insurance agent, it doesn’t have to be.

This guide will help explain and streamline the process so you can secure the funds needed to successfully launch your new business.

Why do I need life insurance for an SBA Loan?

I know what you’re thinking: what does life insurance have to do with my SBA loan? First, it’s important to note that the U.S. Small Business Administration (SBA) does not make or fund its own loans. Instead, the SBA works directly with carefully vetted lenders and approved financial institutions that lend money to small business owners like you.

The SBA minimizes risk for the lender by agreeing to back a portion of your loan. This reassurance makes it easier for lenders to issue funds that help entrepreneurs like you get their businesses off the ground. But the SBA seeks protection, too. That’s where your required life insurance policy comes into play. Life insurance guarantees the loan will be paid in full in the event of borrower untimely death.  

Do all business loans require life insurance?

In general, most lending institutions won’t approve an SBA loan without life insurance.  To assess its need, the lender uses established guidelines to “determine if the viability of the business is tied to an individual or individuals.” In other words, the lender evaluates whether the health and sustainability of the business is based on your involvement.

As the small business owner, your participation is vital to its success. Therefore, it’s almost certain a lender will require you to purchase life insurance before approving your SBA loan. Because your involvement is key to business outcomes, the SBA uses the term “key man insurance” to describe the act of taking out coverage on yourself for businesses purposes. We’ll revisit the idea of “key man insurance” later in this guide.

 Here are some common business types that typically require life insurance:

  • Single-member limited liability companies (LLCs)
  • Single-shareholder C or S corporations
  • Sole proprietorships
  • Certain partnerships (e.g. law or physician practices)

What does “collateral assignment” mean?

By now it should be clear that life insurance is a must when securing an SBA loan. But in most cases, simply purchasing the policy isn’t enough. There are several categories of small business loans available through SBA’s 7(a) loan program (link to the categories?), and each carries its own set of requirements. One common requirement you’ll likely encounter is collateral assignment.

What does that mean exactly? In a nutshell, when a collateral assignment is made on a life insurance policy, the lender is entitled to collect the proceeds of the policy if the borrower dies before it is repaid in full. The lender collects the amount that is still owed on the loan, and the borrower’s beneficiaries then receive the remaining death benefit or policy cash value.

How do I know if collateral assignment is required?

Determination of collateral assignment is based on several factors. For example, the SBA requires lenders to collateralize standard loans over $350,000 “to the maximum extent possible.” And for most small business owners in that category, it means purchasing a life insurance policy.

Other circumstances require collateral assignment even if you apply for a loan of lesser amount.  For example, the ability to meet the minimum acceptable credit score, how much other collateral you can provide to secure the loan, and whether the SBA will guarantee the loan, are all factored into the equation. Another common piece of criteria is the extent to which the business depends on your active participation, which we outlined earlier in this guide. The bottom line is that most small business owners need to purchase life insurance.

Collateral assignment: how it works.

Here are the key terms and conditions of collateral assignment on a life insurance policy:

  • borrower must be the owner of the policy
  • lender is the designated assignee
  • borrower is the designated lendee
  • lender can collect up to the amount required to repay the loan
  • collateral assignment terminates after the loan is paid in full

Does the amount of life insurance have to match the loan amount?

Yes. The required life insurance policy you purchase must be proportionate to the amount and term of the SBA loan you secure. For example, if you get a $400,000 loan with a 10-year term, you will need to purchase a $400,000+ life insurance policy with a term of 10 years or more.

Additionally, when collateral assignment is required, the amount and type of collateral available to repay the loan can be taken into consideration when determining the appropriate amount of life insurance. But any way you spin it, coverage must match the size of the SBA loan.

Can I use my existing life insurance policy to secure an SBA loan?

Already have life insurance? If so, you might be wondering if you can simply use your existing policy to help secure an SBA loan. Simply put, it’s not advisable. The SBA technically accepts some in-force life insurance policies that satisfy the terms of the loan, but it poses risk to your family’s future.

If your original intent when buying life insurance was to provide long-term financial protection for your family, you are better off keeping that policy separate from your business affairs. Why? Collateral assignment would require you to assign the policy to the lender until your SBA loan is paid back in full. It’s safer—and smarter—to get a new life insurance policy altogether.

Will my medical issues prevent me from getting life insurance?

It’s common to worry that medical issues might disqualify you from getting a life insurance policy. You should be relieved to know that some medical conditions have little to no bearing on your ability to secure the coverage you need for an SBA loan.

That said, there are some more serious issues like diabetes or cancer history that can impact the likelihood of qualifying for traditional life insurance. But don’t leave the process to guesswork. The most prudent course of action is to work with a reputable agent who is equipped to assess your situation and find you the best life insurance carrier and rate. A credible agent can vet different companies and find suitable options at no additional cost to you.

I have other investors. Do I still need life insurance on myself?

As mentioned earlier, when you apply for an SBA loan, the lender works to determine the impact of your sole involvement in the company. They do this even if there are other investors in the mix.

Let’s say you are the founder or even an employee whose role is so significant that the health of the company depends on it. In this scenario, you are considered a “key person” or “key man,” and life insurance is necessary to protect the SBA loan. In other words, if a key man passes away or is suddenly unable to manage critical operations, it’s unlikely the business will survive, and the loan is at risk of going unpaid.

How does key man life insurance work?

When your new business includes other investors or constituents, the company usually purchases key man life insurance on your behalf. Additionally, they serve as the policy’s primary beneficiary and also pay the premiums.

Once coverage is secured, the policy funds can be used to reimburse investors or find a replacement should you unexpectedly perish or suffer disability. No, it’s not a feel-good topic, but it’s reasonable for investors to ask, “what happens to my money if you’re suddenly out of the picture and the business crumbles?”

A key man life insurance policy provides investors with reassurance that their money is safe regardless of what happens to the company founder or most essential employee.

Can I get term instead of permanent life insurance?

The short answer is yes. Most times, a term policy makes the most financial sense and is the most used type of life insurance for an SBA loan because the cost can be up to 20 times less than a permanent policy. However, be mindful that the premiums meet your budget since the policy must remain in force for the duration of the loan. Should you miss or delay a payment, your lender will be notified right away.

And remember— whether you secure a permanent policy or a term policy, the term and amount must match that of your SBA loan.

Do I need disability insurance for my SBA loan?

Disability insurance is by far one of the most overlooked—yet critical—types of insurance a small business owner should consider. Also called “paycheck” insurance, disability insurance provides key financial protection you need to pay the bills and keep your business afloat if you become ill or disabled.

Contrary to popular belief, illness trumps accidents as the #1 cause of disability. As a small business owner, the success of your enterprise lies in your ability to show up each day and manage the operation. If you fall ill or suffer another type of debilitating condition, things would go downhill quickly on the business side. Specifically, you might not be able to pay your life insurance premiums, stay current on SBA loan payments, or simply pay the rent.

While the primary focus of SBA requirements is on life insurance for good reason, lenders can also require disability insurance. Either way, it’s advisable to purchase a long-term disability insurance policy with at least a 5-year term period.  This will insulate you and your small business from any likelihood of financial ruin. How? The way it works is that a disability insurance policy with a 5-year term would pay out 60% of your annual income in monthly installments for 5 years.

I need an SBA loan now. How do I get fast coverage?

Racing against the clock to meet the SBA loan application deadline? You’re not alone.  And don’t panic— you have some options available to secure a life insurance policy quickly.

One avenue to consider is purchasing life insurance through a company that offers no-exam policies. No-exam policies are issued through an accelerated underwriting process, meaning a paramedical exam is not required to get life insurance coverage. If you meet the good to average health criteria, these companies can often issue you a life insurance policy in a matter of minutes to several days.

The process is simple and streamlined:

1. You answer a series of specific questions about your health.

2. Company accesses your information from different databases.

3. They assess your responses and background.

4. You receive an answer about coverage.

What if I don’t qualify for accelerated underwriting?

If your medical history is more complicated, or you simply prefer a more traditional route, it can take about 2 to 6 weeks for an answer about life insurance coverage. Why the delay? For starters, the underwriting process requires a 30-minute no-cost paramed exam at your home or office. Also, at the discretion of the underwriter, your medical records may be requested from your physician, so you must wait until those are returned and then reviewed before the policy is approved.  

It’s worth noting that policies secured through accelerated or no-exam underwriting typically carry a limit of $1 million in coverage or less, depending on the insurance company. For reference, typical SBA loans are usually less than $500,000. If you need more than that, you will have to may need to pursue a fully underwritten policy, a process that can take one month or more to complete. A great life insurance broker will keep you up to date and help facilitate the underwriting process along. They can also contact your loan officer and provide documentation on the life insurance application.

Recap: SBA loan and life insurance requirements

Let’s recap. As you can see, securing an SBA loan requires more than just submitting an application. You will also likely need to:

1. Obtain the right life insurance from the start.

2. Get approved.

3. Pay the premiums for the life of the SBA loan to place the policy inforce.

4. Confirm the life insurance policy is collaterally assigned to lender.

Failure to follow protocol may result in unfavorable outcomes for you and your business. Most notably, your SBA loan may be denied. If the loan was approved already, you could put yourself at risk of defaulting and accelerating payment on the balance.

Don’t wait. Get the expert guidance you need right now. Use an experienced agent

An experienced life insurance broker will do the homework and shop the market from the top carriers up front to make sure you receive the best rate whether you’re in excellent shape or have some health issues. They will also keep you and your loan officer updated throughout the underwriting process. Additionally, a great broker will assist you with the final step which is the collateral assignment form.

Sure, understanding the life insurance requirements for an SBA loan is a lot to digest. But you don’t have to navigate the process alone. To meet your business goals and needs quickly, the best decision you can make is contacting a trusted industry expert.

Receiving pointed guidance from a life insurance professional will ensure you get the coverage you need to secure an SBA loan and launch your small business successfully.