If you’ve borrowed money, whether for personal or business reasons, you should consider loan protection insurance. Owing money to another person, bank, investor, or company creates debt. Typically, someone beyond yourself is responsible for that debt.
For instance, if you pass away, your spouse gets the privilege of paying off your mortgage by himself/herself.
If you have a business loan and become disabled, the business may have to sell equipment or equity to make the bank whole.
If you have debt, loan protection insurance can help make sure it is paid off if you become disabled or die.
If you’re beginning to learn about loan protection insurance, feel free to peruse this entire article. The beginning of this article mainly discusses business loans. If you’re not here for that, then feel free to skip ahead to personal loans.
*Please note that the minimum loan amount should be 100k for most policies. Student loans are the only exception.
The Two Types of Loan Protection Insurance
The first kind is for businesses. This includes loan indemnification coverage, business succession paybacks, and a variety of other debt or loan repayment strategies that business owners use to protect themselves.
The second category covers your personal finances. Debt from mortgages, student loans, and a host of other personal loans are not forgiven just because you’re dead or disabled.
Let’s explore each in detail.
Business Loan Protection Insurance
As mentioned, there are a number of different types of business loans. The main difference between business loan protection insurance and personal loan protection insurance is that, on the business side, the coverage is likely required by the lender.
From something as simple as a bank loan to a complex transaction involving venture capital, most lenders are going to require some type of protection, should the business owner be unable to fulfill their obligation.
Different lenders have different requirements. Like buy-sell arrangements, death is the most common provision. Some lenders (the smart ones) will also require a policy if the business owner becomes disabled and is unable to repay the loan.
LOAN PROTECTION USING LIFE INSURANCE
As mentioned, a smart lender is going to have a strong loan protection plan, purchasing an insurance policy on the business owner’s life or having the business owner collaterally assign an existing life insurance policy.
Simply put, the death of the business owner, who is responsible for the loan, puts the lender in a difficult position. Banks don’t want to have estate sales of your equipment to recoup their costs; they just want their money. Similarly, if you’re acquiring a business from a previous owner, the last thing that person wants to do is sue your grieving family to fulfill your obligations.
Protecting business loans using life insurance is relatively easy. Depending on the urgency of securing the protection, there are normally four routes you can consider.
① The Match Game
Since many business loans have a relatively short obligation, term insurance will normally suffice. Term insurance can be used to match the debt repayment obligation timeframe.
For instance, if your bank or investor loans you money that is repayable over 10 years, you can simply purchase a 10-year term policy to repay the loan should you pass away during the loan repayment period.
The underwriting for this type of loan protection insurance can vary based on the obligation.
If your loan is relatively small (250k-500k), then you may qualify for a policy that doesn’t require a medical exam. Larger loans will normally require full underwriting.
Either way, if this strategy fits the bill, it is often the least expensive (although often the more time-intensive) of all of the life insurance loan protection plans.
② The ART Strategy
If your loan is less than 5 years, it will be difficult to find a term policy to match your loan obligation.
This is for two reasons.
One, term insurance doesn’t normally go below 5 years, and two is a little-known life insurance term called “need and purpose.”
Need and purpose is something the underwriter of your case needs to consider.
Put simply, it means the insured’s death needs to create a financial loss for the beneficiary of the policy.
When purchased for a cause, such as income protection, there are guidelines that the insurance companies follow.
For example, having 20 times your income in term insurance when you’re 35 years old or 10 times your income when you’re 55 is relatively easy to qualify for.
That being said, if your loan term is only 2 years, what is your lender’s “need and purpose” beyond the second year?
If your only option is to purchase 5-year term, and your lender is going to own the policy, then the policy may not be approved.
One option to overcome this is to use ART.
Not the kind you hang on a wall or look at in a museum, in insurance parlance, ART stands for “annual renewable term.”
An ART policy is typically applied for the same way a 5, 10, or 20-year term would be. The only difference is that the policy premiums are not level. The price of an ART policy will go up each year.
From a cost perspective, ART becomes unreasonable to hold past the time it is actually needed. Therefore, it is perfectly suited to pass a “need and purpose” test with an underwriter.
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