In today’s economic climate, lenders may ask for something that hasn’t usually been a requirement until now: life insurance on all the parties involved in the loan repayment (meaning you and any guarantors).
Years ago, requiring a borrower to get life insurance and then assign enough of it to the lender to pay off the loan in case the borrower died was pretty common. The requirement disappeared as competition amongst lenders heated up but now it’s back.
In most cases, a term life insurance policy is enough. Just make sure the face value (the amount paid if the insured person dies) is enough to pay your share of the loan and any other costs your business might incur if you die suddenly. If there are other loan participants or guarantors they’ll need life insurance as well.
There are two basic types of term life insurance:
- Level premium: The payment stays the same for a guaranteed period of time, which is generally between 5 and 30 years.
- Annual renewable term: The premium goes up each year, starting lower than level premium term life insurance but quickly getting more expensive for the same face value.
If you have long-term or more complicated life insurance needs you may want to obtain a lot more term life insurance. Then this insurance can function on multiple levels in the event of an unexpected death by acting as a loan guarantee, providing key-person insurance for business liquidity needs, and possibly funding a buy-sell agreement.
If you want this life insurance to endure beyond the period required for a loan guarantee you have to keep in mind that (1) if you choose term life insurance, make sure the level-premium period (the term) is equal to the period you plan to be in business and (2) annual renewable term life insurance probably won’t work here.
To get maximum functionality out of your life insurance policy, you may need to consider one of the many forms of “permanent” life insurance. This is much more expensive but offers a wealth of options and flexibility.
Once you’ve been approved for and actually purchased the life insurance, you’ll need an “assignment form” of some sort to make the lender the beneficiary of enough of the proceeds to pay off the loan balance if you die. This form is usually provided by the insurance company but may come from the lender. Using this form, you make the lender the beneficiary of whatever amount is needed to pay off your loan (not a fixed dollar amount). You also name the normal beneficiary or beneficiaries who will receive the balance.
Note that while a lender can normally require you to get enough life insurance to pay off a loan, lenders usually aren’t allowed to require you to buy insurance through them, their subsidiaries, or any place they recommend.