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SBA Loan Life Insurance Requirements
The Small Business Administration is one of the most essential parts of the government for small business owners, as the agency is uniquely responsible for overseeing and administering SBA loans that can help cover expenses and get smaller businesses off the ground. The administration has long worked to make these loans both more accessible to the public and less risky for the institutions that do eventually extend them to business owners. One way to increase availability while reducing risk has been to require the attachment of a life insurance policy to the loan.
This is not the first instance of a life insurance policy being required to collateralize a major loan, as the process is routinely done for other business loans, as well as certain loans for homeowners. The insurance policy is typically taken out in a term format, with a term that matches exactly the length of the loan's repayment period. There are a number of key reasons for this requirement, and a number of key considerations to be made by borrowers who own a small business.
The Justification: Why Term Life Insurance Matters in Lending
The loans made by the Small Business Administration are generally not small, with amounts that typically start in the tens of thousands of dollars. That exposes financial institutions, as well as the federal government, to a significant amount of financial risk. This risk includes not only that the borrower may default on their own, but also that they may simply die before the balance is repaid. Because many estates are structured to preclude a settlement of loan balances with banks upon the borrower's deaths, lenders stand to lose thousands of dollars if this happens.
The solution is to pair a new or existing term life insurance policy with the loan. This will allow the full balance of the loan to be repaid by listing the lending institution as a beneficiary on the insurance policy. If consumers have an existing life insurance product already in place to cover their loved ones and other expenses, banks can actually attach the loan to that policy through a process known as collateral assignment.
The collateral assignment of new debt to an existing policy is a somewhat controversial process and isn't performed by all lenders. Those lenders that refuse to engage in collateral assignment will simply require the borrower to take out a separate term life policy for the loan.
Effects of Term Life Insurance Collateralization for Borrowers
The single biggest consideration for most borrowers when they learn about collateralization is the overall cost of the term life insurance product that will be paid on top of the existing loan balance and interest charges. The good news for borrowers, though, is that many banks will actually open the term life insurance policy for their SBA borrowers and build that cost right into the loan itself. There is often no separate cost incurred by borrowers.
Furthermore, term life insurance policies are very affordable, with costs that won't add very much to the overall balance of a small business loan. Because most Small Business Administration loans are quite large, with a long repayment term, the added cost of life insurance is negligible during repayment.
Family Impacts: Protecting Loved Ones from Loan Repayment
It's true that many estates are setup to actually deny banks full payment and settlement of outstanding loan payments when someone dies. This is not a universal method of constructing estates, however, which is something that borrowers and their families should be aware of when interfacing with both the SBA and the agency's lenders. In cases where the estate is not setup to evade debts, the family surviving the borrower will generally be responsible for taking over payments and satisfying the outstanding balance.
The sheer size of most SBA lending products can cause this to be a significant burden on the family, especially in cases where the deceased is the primary business owner and the primary breadwinner for the family. This is an obligation that cannot be left up to chance, which is why securing a proper term life product just makes sense for the borrower, the SBA, the lender, and the borrower's family.
Not the Only SBA Insurance Requirement When Borrowing for Business
The Small Business Administration could best be described as highly risk averse, with a number of key insurance and liability benchmarks to be met. Borrowers are required to obtain life insurance for a loan of any size, no matter its term, and they are secondarily required to obtain flood insurance to protect against major personal and business losses.
The Small Business Administration has also set out a series of tough guidelines for how a life insurance policy should be restructured in order to ensure full repayment of a loan if the borrower dies. Lenders will explain these requirements at the time the loan is originated, but they generally include statements of responsibility, conditions that invalidate the loan, the policy, or the obligation to repay, and other concerns.
With careful attention to detail and a thorough understanding of
why life insurance is so important when borrowing from the SBA, business
owners will be able to make sound fiscal decisions now and into the
future. That bodes well not only for the borrower's business, but
for his or her family as well.