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Securing an SBA is a lengthy process. There are several steps to take and many requirements to take. It can take several months from the initial application to the funding of your loan. Borrowers often find themselves frustrated between steps or stressed when they hit unexpected hurdles.
What’s one hurdle that takes many borrowers by surprise?
The life insurance requirement. Most SBA loans require borrowers to have life insurance before the loan is finalized. The need for life insurance can often slow down the SBA loan process. In addition, borrowers aren’t always told they’ll need life insurance until very late in the process, leading to a scramble.
However, you can take steps to prepare and make the process quicker. Our guide will show you what to expect when you’re applying for an SBA loan, explain how life insurance plays a role, and give you some tips to help you along the way.
SBA loans are often for substantial amounts of money. In fact, the average SBA loan is just over $100,000, and loan amounts can reach as much as five million dollars.
Loans of that size leave the government and the lenders they work with at considerable risk if the borrower were to pass away before paying back the loan in full. One way to guard against these losses is with collateral.
Collateral is a term used to describe an item of value that could be used to repay on a loan if payment stops. Some types of loans, such as car loans and mortgages, have collateral built-in. That’s why banks will repossess cars or foreclose on mortgages if payments stop.
SBA loans are in danger of not being repaid in the event of an unexpected death. That’s why they often require life insurance policies as collateral. A life insurance policy you are often required to take out when obtaining an SBA loan will be used to pay the remainder of your loan balance if you die before you finish making payments.
You’ll be required to take out a life insurance policy that has a death benefit amount that is at least as much as the entire amount of your SBA loan. You can also choose the type of life insurance policy you want, but most people prefer term insurance as it is the most affordable.
However, if you choose to take out a term insurance policy, it will need to have a contract length that is at least as long as the repayment terms of your SBA loan. Plus, your life insurance policy will need to be active before your loan can be approved.
It is imperative to understand that your lender isn’t the beneficiary of your life insurance policy. Instead, your life insurance policy will need to designate as a collateral assignment to your lender.
You’ll still need to name a beneficiary of your choosing to receive your policy payout. Should you pass away while your life insurance contract is active, the payout of the death benefit would be distributed first to pay off the balance left on your SBA loan. Any remaining death benefit would then be paid out to your beneficiary.
Since your loan balance will depreciate over time, it would not make sense to name the lender as the beneficiary. Think about it this way; let’s say you have five years into your life insurance policy and have made five years of payments towards your loan balance.
That five years of payments towards your loan balance will have likely reduced the total payoff amount by quite a bit. Now, look at the death benefit of your life insurance policy. The death benefit of a life insurance policy stays the same. It doesn’t go down.
If you were to name the lender as a beneficiary and you passed away, let’s say five years after making several payments towards your loan, the insurance company would still be required to pay the full death benefit to the lender.
To avoid this from happening, life insurance companies offer collateral assignments. A collateral assignment is a policy form that names the lender as an assignee of the policy, similar to a beneficiary.
However, an assignment still allows you to name a primary beneficiary that would be entitled to any remaining death benefit left over after the lender has been made whole on the loan balance due.
To see how this works, let’s say a woman named Monica owns a small business. Monica takes out a $500,000 SBA loan that is structured to have a 20-year payment plan.
Monica’s SBA loan requires that she take out a life insurance policy equal to the loan amount. Accordingly, she purchases a 20-year $500,000 term life insurance policy with her spouse listed as the beneficiary and the lender as a collateral assignee.
As Monica pays down her loan, the payout amount due to the lender would lessen, giving her spouse a larger piece of the death benefit if she were to pass away.
After Felicity finishes paying off her loan, she could still hold the $500,000 life insurance policy, and her spouse would receive the total payout if Felicity died unexpectedly.
SBA loans can be very competitive, and the process can be a little complicated. It’s a good idea to make sure you meet all the requirements before you sit down to apply. You can gather all the financial and other information you need to make the process easier.
You’ll need to:
Your business must be physically based in the United States
Have a for-profit company – Non-profit companies aren’t eligible for SBA loans.
Have a business in an eligible industry – Certain industries aren’t eligible for SBA funding. This includes companies involved in gambling, money lending, life insurance, politics, and business that only earn passive income. In addition, individual lenders might have their own lists of ineligible industries.
Meet size requirements – The exact size requirements depend on your industry. Some industries allow businesses of up to 1500 employees, while others cap the max at only 500. Similarly, maximum revenues must be less than $7.5 million annually. You’ll also need a net worth of less than 15 million to qualify. These requirements change regularly. You can use this tool to check current standards.
Pass a background check – You’ll have a more challenging time getting an SBA loan if you have a criminal record. However, it’s not impossible. It will likely depend on the severity of your past offense and how long it was. You should be prepared to answer questions from your lender about your criminal background in this situation.
Present documents that show the strength of your business – You’ll need to show your lender evidence that your business will succeed. A detailed business plan is a requirement. In addition, it’s a good idea to layout your product or service, marketing strategies, existing financial records, and projections. Resumes of your company’s management team can also help secure a loan. They can show lenders that your business is being led by people with experience and skills.
Present financial records and documents – Your lender can ask to see a variety of financial records. This might include tax records, bank statements, business financial statements, and payroll documents.
Have solid personal credit – Lenders will look closely at your credit when applying for an SBA loan. It’s a good idea to pull a copy of your credit report before you apply. You can make sure your credit is excellent and can check for errors in your report.
Have strong business credit – New businesses might not have a business credit report yet. However, companies that have been around for a few years will have a business credit report and score. Just like your personal credit, you’ll stand a better chance of securing a loan if your business credit is excellent.
There are several steps in the SBA loan process. Following each step carefully improves your chances of a successful loan application. Steps in the process are outlined below.
Choose the best loan program for your business – The SBA offers several loan programs, including temporary programs to help small businesses during the COVID-19 pandemic. The most popular program for small businesses is an SBA 7(a) loan, but it’s good to carefully look over all the different loan options.
Choose a lender – The SBA works with many lenders to offer loans to small businesses. You can look through the lenders available in your area to see teams, rates, and amounts. It’s important to choose a lender that offers terms that will work for your business and has a track record of successfully working with the SBA and small businesses.
Fill out your application – Your loan application will ask you for detailed information about your business and personal finances. You’ll need to provide detailed information about your business, current financial state, and future plans. You’ll generally need to provide information about your personal history and personal finances as well. The exact application will depend on your loan program and lender.
Receive a “Letter of Intent” – A “Letter of Intent” is a statement from a lender that you meet the initial criteria for a loan. It is not an approval. This is because your loan hasn’t yet gone through full underwriting. The ‘Letter of Intent” will let you know your interest rates and monthly payments if you are approved. You’ll need to sign this letter and send it back if you agree to the terms.
Wait several weeks during underwriting – SBA loan underwriting can take several weeks. There’s not much you can do during this time. Your lender will look over all the information you provided. They’ll pull your credit report, criminal record, and other data. This information will be used to determine your eligibility for a loan.
Receive a decision – Although it might sound like the last step, there’s actually still more to do after you receive approval. Your loan will move into the closing stages, and the lender will make sure you and your business have everything in place to receive your loan.
Secure a life insurance policy – You won’t be able to finalize your loan until you have a life insurance policy in place. As stated above, your life insurance policy will need to be at least as large as the total amount of your loan, and your term will need to last at least as long as the repayment term on your loan.
Make collateral assignment – You’ll need to have collateral assignment documents on your life insurance policy sent to your SBA lender. This can take up to a week. You’ll receive your funds once your lender receives and reviews these documents.
