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How Business Owners Use Life Insurance to Cover Business Loans

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If you are a business owner, you know that businesses need infusions of cash on a regular basis. Whether you are starting a business or growing an established company, you need capital to get going. Capital, in the form of cash, is necessary to open the doors of your business. It’s required to expand into a new marketplace. Cash is needed when setting up a new branch or division.

Sometimes you can access this money from currently-owned business assets or accounts, but more often than not, you need outside resources to make your dreams a reality. You have multiple options when it comes to getting a business loan, such as turning to commercial or private lenders and even investors to obtain the capital you need. But regardless of where the money comes from, one thing is consistent: your lenders will want their money back if you default on the balance or die before the loan is paid back.

Why Life Insurance Matters

This is where life insurance comes in. Lenders typically will not close a deal until a policy is in force. They simply don’t want to have to chase down the surviving family members, or the executor of the estate in order to get their balance due. The life insurance benefit will provide the exact amount needed exactly when it is needed. That’s one major creditor that family and business associates don’t have to worry about.

Here are three quick tips for business owners for using life insurance to indemnify a bank loan or other debt:

1. Purchase Your Policy First

Life insurance underwriting can take several months, especially if a history of serious illness has to be reviewed. Don’t wait until the last minute to get prequalified and submit an application. The last thing you want is to be conditionally approved by a lender, only to have to delay closing because your insurance is not yet final. If there is an overlap of time and your banker starts getting antsy, make sure your broker reaches out to him to reassure him that the process is underway.

2. Forget About Loan Protection Policies

Lending institutions will often offer life insurance to indemnify their loans. These products are sometimes called “Loan Indemnification” policies, or “Mortgage Protection” policies. They are simply term insurance with a face amount that decreases as your loan is paid back. But the vast majority of the time, they are more expensive than a straight term policy you can buy in the open marketplace.

3. Choose Your Beneficiary Wisely

Sometimes business owners think the lender has to be the owner and beneficiary of their life insurance. Not only is that not true, but it’s also not a good idea.

Let’s suppose you have a policy for $2 million, to match the initial amount of the loan. After five years, you have paid off $500,000, leaving a balance of $1.5 million. Tragically, you pass away, leaving the loan unpaid. If the bank is the beneficiary, they will get the full $2 million, $500,000 more than they are owed.

The wise choice is to make a family member or other sensible entity the beneficiary and then use a collateral assignment to ensure the lender receives his benefits. When a claim is paid, the insurance company will then make the lender prove the balance due, pay them, and give the beneficiary the rest. In this way, everybody gets what they deserve. As an added bonus, by making yourself, your business, or a trust the owner of the policy, you prevent the lender from tampering with the policy.

As we’ve seen in previous articles, life insurance is vital to the success of a business owner. It protects you, your family, and your business, and gives you peace of mind if unanticipated events happen. With so many details involved in running a business, it’s easy to overlook something like the need for life insurance to pay back loans. Let me help you find the best policy and answer any questions about how life insurance can make a difference for your business. Ask anything by emailing me at skobrin@stevenkobrin.com.

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