The Role of a Term Life Insurance Policy for SBA 7(a) Loans

Are you considering applying for an SBA 7(a) loan to grow your small business or start a new business? If so, you may come across a requirement that some banks have - the need for a term life insurance policy. But what exactly is the role of a term life insurance policy for SBA 7(a) loans? Let's explore this topic in more detail.

What are SBA Loans?

SBA loans are government-backed loans designed to assist small businesses in obtaining necessary funding. While the Small Business Administration provides a guarantee that the borrower will repay the note, banks also have their own internal lending requirements to mitigate risks associated with lending money. These additional requirements are set to ensure that the loan can be repaid in full and on time. Although not all banks impose this condition, some institutions mandate borrowers to obtain a life insurance policy as an added layer of security in case the borrower passes away before completing the loan term.

Why Do Some Banks Require a Life Insurance Policy for SBA Loans?

Although not all banks require it, some may ask borrowers to secure a term life insurance policy as a safeguard in case the borrower passes away before the note matures. This requirement helps banks reduce their risk and ensures loan repayment even under unforeseen circumstances. Life insurance is particularly significant in the context of SBA loans. It acts as a security measure for banks, guaranteeing that if the borrower dies before the loan is settled, the bank will still receive the outstanding balance from the life insurance policy. This reduces financial risk for the bank and assures repayment regardless of the borrower's situation.

The Process of Obtaining a Life Insurance Policy for an SBA Loan

If your bank requires a term life insurance policy as a condition for securing an SBA 7(a) loan, you will need to follow several steps. First, you must apply for a life insurance policy through an experienced insurance broker and/or company. The insurer will have the prospective insured undergo a medical examination to assess the borrower's current health and determine the type of coverage available. The coverage amount would equal the total package price of the outstanding debt, including the purchase price and any additional capital like working capital.

After your medical examination and policy issuance, you will need to fund the policy. This funding is known as your insurance premium. Depending on the arrangement between you and your insurance broker, these premiums could be due monthly, quarterly, bi-annually, or annually.

The Parties to a Life Insurance Policy for an SBA Loan

When creating your life insurance policy, you should opt for a term policy that lasts at least 10 years, which aligns with the typical maturity period of an SBA 7(a) loan. The policy should be on the life of the borrower(s), with the banking institution named as the beneficiary. If the borrower(s) pass away within the term limits, the insurer will pay the policy amount to the bank, settling the outstanding debt.

Make sure to collaborate with your insurance broker to draft a life insurance policy that covers the outstanding balance of the existing note, rather than the entire policy amount being received by the banking lender.

Policy Flow if Triggered

After qualifying for a term policy and getting the policy initiated, the SBA lending institution will issue the funds requested to purchase the target entity. In exchange, your policy will issued to the lender naming it as the beneficiary in the event of the borrowers death.

If the borrower were to pass away prior to the maturity of the outstanding note, the life insurance policy will be triggered and the beneficiary/lending institution will be repaid.

The role of a term life insurance policy for SBA 7(a) loans is to provide security for the lending institution in the event of the borrower's death. While not all banks require it, some may ask borrowers to obtain a life insurance policy with the bank listed as the beneficiary. By understanding the importance of this requirement, you can better prepare yourself for the loan application process and secure the financing you need to grow your small business.