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Life Insurance for SBA Loans: Getting the Right Coverage

Before a bank approves your SBA loan, it is going to ask you for a life insurance policy. Getting the right coverage can be a headache — here's our advice.
Jason Hill, of Client Focused Advisors and the Shrimp Tank Podcast of Boca Raton, shares his expertise with the need for life insurance as collateral in an SBA loan, and how to find the right plan for you.
While a lot of banks accept life insurance as collateral for SBA loans, getting the right coverage can be a headache. There are a lot of aspects that go into consideration when acquiring life insurance for an SBA loan. You need to be careful when choosing coverage in order to make sure you’re getting what you need and are not stuck overpaying for a policy that provides more than is required.

Why Do You Need Life Insurance for SBA Loan?

Before a bank approves your SBA loan, it is going to ask you for a life insurance policy. You will need to secure a life insurance policy for your SBA loan. This is sometimes referred to as collateralization. Lenders need to ensure that the loan is paid, even in the event of an untimely death that occurs prior to the loan payout being fulfilled.

It is unlikely for a bank or lending institution to approve an SBA loan in the absence of a life insurance policy. The banks giving the loan want to make sure they’re protected against any possible risk of not getting the loan paid out in full, which is why life insurance is a must if you’re looking to get approved for an SBA loan.

What Type of Coverage Should You Get?

There are two main types of life insurance to consider, whole life insurance and term life insurance.

Term life is the most affordable and the most recommended option, while the whole life is the most expensive and only used for SBA loans in very rare cases. Unless whole life insurance is your only way out, stick to term life insurance as there is no need to have a cash value buildup for loan collateral.

Learn more with the Complete Guide to Everything You Need to Know About SBA Loans.

Term life insurance has some of the best rates which do not increase over the life of the insurance policy. Also, the amount paid for the term life insurance is strictly for the death benefit and there is no cash value accumulation, so you will avoid paying extra for the investment aspect that comes with a whole life insurance policy.

Many term life insurance policies are set for a specific period of time, usually in increments of 10 years, 15 years, 20 years, and so on. Which makes it a good option as most SBA loans come with a short term for payout.

For instance, if you have a ten-year term loan, then applying for a 10-year term life insurance policy means that it will extend throughout the life of your loan. You can choose more coverage, in terms of years, if you intend to use the insurance for a future loan.

Also, you want to avoid an insurance policy that is lower than your loan amount. When choosing your coverage, you should also consider the amount of your loan. If your loan is $1,000,000 then you will need to apply for an equal coverage amount, so that it will cover your total loan amount.

No Medical Exam Life Insurance

Typical term life insurance for an SBA loan goes through an underwriting process where you need to go through a full medical examination to determine the risk of insuring you, depending on the state of your current health.

It would take up to eight weeks (or longer) for this type of policy to be approved. While this may be the most affordable option, it is not always the quickest option. If you’re looking to get approved sooner than later, you can opt for a no medical exam life insurance policy, which can get approvals within a day to a week’s time. It requires no exam and has an expedited underwriting and application process that is completely electronic in most cases.

The downside of a no medical exam policy is that it will have higher rates and the coverage amount tends to be capped since the life insurance company has no insight into your current state of health, other than what is in your records.

With this policy, you will also be required to answer detailed medical questions and you may face possible rejection if you have certain health problems in your medical records. But if you’re overall a fairly healthy individual, your chances are good to get approved fast.

This is a good option for those who are getting a loan under a million dollars, as most no exam companies cap your coverage at about that amount.

Potential Roadblocks

You may not be able to qualify for certain policies if your health and medical history fail to match the health requirements. In fact, you may face potential rejection by not one, but multiple companies. The policy you qualify for is determined by your general health and medical history. The riskier you are to the life insurance company, the higher your chances of rejection.

However, there is also a chance that a few companies may favor your specific risk. It may take days or even weeks of scouring the internet to find a trustworthy company like this, but it can be made easier if you go through an agent to help you through the whole process. Try to stick with agents that are independent and represent multiple companies. This way they will be able to shop the market for a suitable company.

Working with an experienced agent will help you know which companies issue insurance policies to people in your specific situation. Your agent will provide you with a list of companies that may potentially approve you. This way you can review multiple options and compare rates between multiple carriers.

The advantage of looking for a company that would favor your specific risk is that you may gain more benefits when compared to opting for other life insurance policies with very low face values, which may not be enough to cover your loan.

Setting Up Collateral Assignment

After choosing your preferred insurance policy, you need to fill out a collateral assignment form.

A collateral assignment appoints your lender as a beneficiary of your life insurance policy proceeds. The bank needs to know that it will receive a full amount of the outstanding loan, should you pass on before the loan is fully paid. That is why the conditional assignment is set up.

Also, when setting up your collateral assignment, you need to list a beneficiary of the remainder of the proceeds once the loan is paid in full. Hence, a collateral assignment is a way to protect your family as well as your business in that, the remaining proceeds are directed to whoever you listed as your beneficiary.

The insurance company will receive the collateral form signed by you and the bank to show that the remaining loan balance will be reimbursed after your death. Since there are beneficiaries listed on your collateral assignment, the lending institution will not be able to claim insurance proceeds exceeding what you owed them in the event of your death.

When the loan is fully paid, the collateral assignment equally gets terminated.

Bottom Line

Getting the right coverage for your SBA loan life insurance policy doesn’t have to be daunting. Don’t make rash decisions before finding out what would work for you and what would not. Determine the amount of your loan and go for a life insurance policy that coincides with that amount. Also, you don’t have to pay high premiums or get coverage with a low face value if you qualify for a higher insurance policy with lower rates. Look for an expert and let them walk you through the process to make sure you get exactly what you need.

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