Small Business Administrators (SBA) loans have been a pillar for small business owners in the U.S. ever since its establishment. However, since the covid pandemic crippled economic activities in 2020, there has been a sharp increase in the number of business owners going for loans. The Covid EIDL was created specifically for businesses affected by covid-19, and over $88 billion worth of loans have been given out.
With more businesses needing financial aid to continue their operations, more attention is being given to SBA loans instead of traditional loans. These loans are also available for new business owners who do not have the required capital to start. By getting an SBA loan, they have the opportunity of getting a loan that does not drain the capital of their business. However, like every other loan, SBA loans require collateral.
Life Insurance as a Collateral Assignment for SBA Loans
Collateral assignments for an SBA loan can be any permissible property of equal or greater value to the loan. Some people use properties, expensive items, real estate, and similar objects. However, many small business owners prefer to use insurance as a collateral assignment for SBA loans.
The deal with using insurance as a collateral assignment is that it performs two functions in one. First, most SBA loans, especially ones under the 7 (a) loan program, require insurance from the borrower. Any property being used as a collateral assignment must be properly insured to ensure that the lender gets his money from the sale of the property if the borrower defaults.
Rather than use property with its value and insure it as double protection for the lender, borrowers often opt for life insurance as an alternative. Using life insurance as a collateral assignment for an SBA loan means that you assign the lender as the primary beneficiary of the loan, which gets the payout if you die before your loan is fully paid.
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The insurance company will pay the lender the amount left from the loan and remit the remaining money to your other beneficiaries.
How Does Life Insurance Protect Lenders of SBA Loans?
Lenders prefer to lend money to businesses borrowing under the auspices of the small business administration (SBA) because the body protects them. The SBA will cover 75% of the total amount owed if the borrower cannot pay. To prevent situations where a borrower cannot pay back his loan, collateral assignments have been given much attention.
If you want to use life insurance as a collateral assignment, you must understand the intricacies of this practice. Here are some things to know:
Term of the Life Insurance Policy
If you want to use life insurance as collateral for an SBA loan, you can use either of the two options available. The term life insurance policy is often used to favor both the lender and the borrower. The policy term may be between 10, 15, or 20 years. In most situations where a business owner buys a term life insurance specifically as collateral for an SBA loan, they set the loan duration as the insurance term.
For example, if a loan duration is 10 years, you can buy term life insurance for 10 years. If you pay back your loan before the expiration date, you can withdraw your payout from your insurance policy or extend the term. The lender receives the payout as the primary beneficiary if you cannot. Any leftover amount is paid to your other beneficiaries.
The second option is the whole term or permanent life insurance policy. This policy lasts throughout the policy owner’s lifetime, and the death benefit is paid to the beneficiaries upon his death. Using a permanent life insurance policy as a collateral assignment is not preferable because it deprives the policy owner of some of the benefits of this type of policy.
Business owners who own permanent life insurance policies can take out policy loans from their insurance company based on the cash value of their insurance. However, this is not permissible to those who use their policies as collateral assignments. Suppose by the borrower’s death, he has not fully repaid the loan.
In that case, the insurance company will pay the balance to the lender before giving the remaining sum to the family or any specified secondary beneficiaries.
Another thing you should note when getting a life insurance policy as a collateral assignment is the coverage. Insurance policies coverage differs, and you should make your insurance agent walk you through the intricacies before settling for one. You do not want to buy a policy with more coverage than you require, just as you do not want less coverage.
Getting the right coverage is key, and you have to do your homework on that. You can go for a policy that only covers your loan amount or a comprehensive one that leaves enough money for your other financial obligations.
Other Things to Know About SBA Loans and Life Insurance
There are a few other things to know about SBA Loans affecting life insurance. They are:
People Got Life Insurance Out of Fear
While many business owners got life insurance as a collateral assignment for a loan, others got it because they were scared. The pandemic was raging here, and the death toll was rising steadily. So many people got life insurance to help their families if they died.
Some Life Insurance Policies Cannot Be Used as Collateral Assignment
Some insurance carriers do not allow life insurance policies as collateral assignments. Ask your carrier about the insurance carrier eligibility before buying a policy. If you are just about to buy the policy, you can opt-out and choose a carrier that permits it.
Suppose you already had a policy with the company before the loan. In that case, you can talk to your agent about transferring your plan to another carrier that allows insurance policies to be used as a collateral assignment. You can also modify your policy to assign the lender as the primary beneficiary of our traditional life insurance.
Many businesses fall on SBA loans when they cannot use traditional loans from banks and other financial institutions. In addition, the covid pandemic made the administration responsible for more business owners who are struggling due to financial strain. These business owners need to get life insurance as a collateral assignment for their loans to get the needed funds.