Obtaining business funding can be a little challenging, especially for a startup or young company. Lenders usually require some type of collateral from the business owner(s). Life insurance is often part of that requirement. It’s used to protect the lender in the event of the borrower’s death. In this article, I’ll discuss how life insurance can help secure a business loan.
Type of life insurance and policy structure
Term life is the most commonly used type of insurance for loan collateral. It’s the least expensive option and can be purchased for term lengths as low as 10 years. It’s important to structure the policy in such a way that the lender doesn’t receive any more money than the current loan balance in the event of the borrower’s death. This is accomplished by granting collateral assignment to the lender, as opposed to simply making the lender the policy’s beneficiary.
With a collateral assignment, any remaining death benefit will go to the insured’s choice of beneficiaries. A spouse, children, other family members, a charity or the company itself. Anyone really. This split automatically changes over time as the loan is paid off. Because of this, buying a policy with a term that’s longer than the projected loan payoff is a great way to lock in low rates for coverage that eventually will benefit chosen beneficiaries entirely. Life insurance rates go up with a person’s age so, at the end of a 10/15/20 year loan period, the cost will be significantly higher for the same amount of coverage on a new insurance policy.
When time is of the essence
It’s not uncommon to find out at the eleventh hour from a lender that life insurance will be a requirement. This tends to happen a good bit with SBA loans. If the applicant is healthy and the required coverage doesn’t exceed the limits of no-medical exam policies, that’s usually the way to go. No-medical exam policies are much quicker to put in force than their fully underwritten counterparts.
If there are medical conditions or other factors that render the applicant ineligible for no-medical policies, then it becomes imperative to apply with the right insurance company for the situation. The wrong choice will cost valuable time. The process can be lengthy with fully underwritten policies and if the application is declined the only option is to apply again with a different company. Effectively starting the entire underwriting process all over.
Insurance company & policy selection
Every life insurance company will assign a different level of risk to a specific health condition or background blemish (bankruptcy, multiple speeding tickets, etc), so it helps to get it right the first time. Also, some companies don’t offer the option of collateral assignment at all.
Working with a knowledgeable life insurance broker is the best way to obtain the lowest pricing for the needed coverage. More importantly, good field underwriting will identify the insurance companies & policies that the applicant qualifies for and that will offer the best turnaround times.
Getting your ducks in a row early
If applying for a business loan, I strongly suggest asking the loan officer at the beginning of the process if life insurance will be required. Worst-case scenario, a request to push out the closing date on the loan can be made if it’s clear that there won’t be enough time to get a policy in force. That being said, not only is this impractical but also has the potential to cost the business profits and/or to run the risk of falling out of contract on a purchase agreement if the loan is needed to buy an existing business.
In my experience, every business owner should have life insurance in place whether or not a business loan is in their future. Owning & operating a business comes with financial responsibilities to other people. Employees, business partners, spouses, lenders, investors, suppliers, etc. Life insurance, along with a good contingency plan, is an inexpensive way to provide protection to those who would be impacted by the death of a business owner.
To discuss how life insurance can help secure a business loan and/or provide a contingency plan for your company, feel free to reach out. Consultations and quotes are always free.
You can either start the process by running your own quotes on any page of this site, or you can call, text or email me directly.
-Danny Gallant, Life Insurance Broker
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