Small Business Administration (SBA) loans are easier to apply for than ever before thanks to online applications and submission. They can be a terrific financing alternative for businesses that are seeking more favorable loan terms or in some cases, for businesses that may not qualify for a traditional small business loan. The SBA generally offers greater flexibility in terms of required borrower equity investment, inclusion of funds for working capital, length of time of repayment and other factors designed to enhance the opportunity for success of the small business.
In 2021, there were 61,000 loans through the SBA’s core lending programs. The equivalent of 4.8 billion dollars. If you are an entrepreneur and are considering an SBA loan, it may benefit you to learn about the life insurance requirements of the SBA.
One way the SBA protects itself is by requiring life insurance for those who are responsible for the loan’s repayments. This is because most of the time a small business has one or a few “key” people who the business might not survive without.
SBA loans don’t actually come from the SBA. The SBA works with a network for approved financial institutions that lend money to businesses. However, the SBA does guarantee the loan. In essence, they are backing the loan, which is great for financial institutions as the SBA will pay back the loan if the recipient defaults. The SBA reduces their risk by requiring you to hold several types of insurance, including “Key Man” life insurance. Your life insurance policy will act as collateral and reduce the risk for the SBA.
The SBA states that “the lender must require life insurance unless the lender determines due to the adequacy of collateral and/or the presence of secondary sources of repayment that life insurance is not necessary.” Essentially this means that if there isn’t a really strong succession plan and/or a secondary source of repayment then the lender will have to make sure the borrower has enough life insurance to pay off the loan after liquidation of whatever collateral the business has.
Therefore, the coverage amount is required to be as much as the loan. For example, if you take a loan for $500,000, your life insurance policy must be worth the same amount. You must hold the life insurance policy for the term of the loan. For this reason, many people choose term life insurance for their SBA loan. The life insurance policy gives the SBA collateral assignment. This means if during the course of your loan you pass away, your insurance will pay off your loan first, then any remaining money will go to the beneficiary.
Navigating the world of insurance can be complicated. One of the primary challenges is in timing, as the SBA often waits until the last moment to make applicants aware of the life insurance requirement. Failing to apply for life insurance at the beginning of the application process can cause a serious delay in closing on the loan, as the insurance must be in force prior to the lender being able to close.
You will want to work with an agent or broker that has experience with SBA loan requirements. This can make the process less stressful and won’t cost you anything extra. Contact a Term Provider agent today at 800.682.2017 to discuss your options for buying a life insurance policy that fits your needs.