What people get wrong about insurance
A private money lender may require that you maintain insurance. This may include fire insurance, life insurance, title insurance, professional liability insurance, business interruption insurance, and more. Before we get into defining each type, it may help to more fully understand the concept of insurance as a whole. It’s a concept that many people get wrong, which in turn causes them to dread the idea of it.
Insurance, as you are likely familiar with, is the practice of pooling financial resources to mitigate risk. People buy individual insurance policies for a monthly, quarterly or annual premium. The premium is small in comparison to the potential loss the policy covers. This is possible because insurance companies set premiums by predicting the amount of loss a portion of their insureds will suffer and spreading those losses among the group.
People often erroneously twist the idea of insurance into a kind of mental bank account. They feel they’ve paid money into it for a length of time, and so they insurance company owes them something. That is not the case – in fact, you should hope you never have to use it. Insurance is there as protection against catastrophe and to provide daily peace of mind. The money only pays out under the very specific losses the policy outlines in the contract. As a result, insurance should make you financially whole from that loss, but not so you can profit from it.
Types of Insurance Policies
The private lender may require you to show proof of a few kinds of insurance prior to closing. The kind of policy you need will change depending on the size and type of loan. This may include:
- Life insurance with the private investor as a beneficiary. If you pass away before paying the loan off and the lender is uncertain that they will be able to recoup the debt from the subject property or from your estate, they may require that you maintain an appropriately-sized life insurance policy. This is more common when the loan is significant, and the business cannot carry on without you.
- Title insurance is not just for the lienholder. The lender will often require that you pay for their title insurance. You can also buy a policy that protects you against any issues with the title or ownership.
- Professional liability insurance ensures that if you are a defendant in a lawsuit, you can still pay your bills. If you have liability insurance and someone brings a lawsuit against you, the insurance defends you and pays out up to the policy’s limits if the plaintiff wins. This safeguards your finances, enabling you to continue paying your loan bill.
- Business interruption insurance may be required to ensure the lender can get the loan repaid should your business’s operations be interrupted. These policies compensate a business for a percentage of its loss of income. Keep in mind that the policy will define the specific causes of business interruption it covers.
- Fire insurance protects you and the lienholder financially should the subject property be destroyed in a covered loss. For example, vandalism, storm, fire, etc. Not all insurance is created equal; the lienholder will want to ensure the policy covers the losses they require. Fire or property insurance does not cover vacant land or raw land; it protects only building structures.
You will need to provide a certificate of insurance for each policy naming the lienholder. In the case of life insurance, the lienholder will be a beneficiary. For other kinds of insurance, including title insurance, professional liability insurance, business interruption insurance, and fire insurance, you will name the lender as an additional named insured. The private money lender will verify that the coverage is appropriate.
If you do not maintain the required insurance, you should be aware that the lender may force place coverage. This means they will place their own insurance to protect against loss and then add the (usually significantly higher) cost to your statement.