By Garrett Sutton, Esq.
Entrepreneurs are typically resourceful when it comes to finding ways to pay the bills or finance growth, but these two sources of small business loans are often overlooked.
Borrowing Against Life Insurance Policies
If you have a life insurance policy with cash value (whole or universal life), borrowing against it should be easy. There is no credit check, the loan generally doesn’t have to be repaid (with caveats below), and the interest rate is usually low.
But there are a couple of possible pitfalls. One is that borrowing against the policy will reduce the benefit to your heirs if you die before the loan is paid back. Make sure you still have enough life insurance. If needed, supplement with a term policy.
The other drawback is that interest will be charged, and if you don’t pay it back, there could be serious consequences. You can instruct the insurer to pay the interest from dividends or from the remaining cash value of your policy, but you may not realize how high the balance has risen. If there is not enough cash value or dividends to cover the loan, your policy could lapse.
Even worse, you may find your owe taxes on the amount you borrowed—plus unpaid interest! Why? Because the insurer is giving you a loan with your insurance policy as collateral. (You aren’t really withdrawing the cash value of your policy; you are borrowing against it.) If you die and the proceeds cover the loan plus interest, your beneficiaries will receive anything that remains. But if the amount you owe (including interest) exceeds your cash value, or if you let the policy lapse or cancel it with a loan outstanding while you are still alive, you run into something called Cancellation of Indebtedness Income.
When you borrow money and don’t pay it back, the IRS considers that cancelled debt taxable income, and the total amount of “income” can include interest that accumulated, but was not repaid. So if you cancel the policy or let it lapse before you repay the loan, the IRS will expect you to include that amount in your income when you prepare your return.
Forgiveness of debt is income.
To be safe, you’ll want to watch your policy closely. Make sure you are working with a knowledgeable agent who understands these risks, and consider paying the interest if failing to do so will put you at risk of owing taxes to the IRS.
Life insurance loans don’t show up on credit reports, however.
In that sense, this can be an excellent way to borrow without affecting your credit scores.
Credit Union Loans
Credit unions may not be the first place you think of when you think of small business loans, but don’t overlook them.
Many credit unions make loans to small businesses in their community, and during the economic downturn, some were making loans to businesses that were being turned down by other financial institutions.
In addition, some credit unions offer smaller loans than some banks, and usually have very close ties to the communities in which they live and work. Some strive to lend to underserved or overlooked businesses. That makes credit unions one of the first places you may want to consider for a loan for your business.
Find out which credit unions you may be able to join at www.ASmarterChoice.org.
For more information please see my book Finance Your Own Business: Get on the Financial Fast Track.