Best Practices: Proposed Rule: Changes to Hazard Insurance Requirements for Smaller Loans

The U.S Small Business Administration (SBA) proposed to amend various regulations governing the SBA’s 7a loan and 504 loan programs, one of which is a change in the required collateral hazard insurance for loans of $150,000.00 or less. The current rule states that for 7(a) and 504 loans, the SBA requires hazard insurance on all collateral and does not distinguish this requirement by loan size. The proposed rule change states that the hazard insurance requirement would remain in place for loans greater than $150,000, but that for loans of $150,000 or under, lenders could follow the hazard insurance policies and procedures they have established and implemented for their similarly sized, non-SBA-guaranteed commercial loans. It is worth noting that this change only applies to hazard insurance, not flood insurance. If the new rule is adopted, SBA lenders must still require flood insurance when collateral is located in a flood zone.

The SBA reasoning for the change is because it can be costly for businesses who need a small loan to purchase hazard insurance. The SBA lending program’s main goal is to provide funding to small businesses, regardless of loan size, but, according to the SBA, the current hazard insurance rule may be preventing smaller businesses from obtaining a loan. The SBA hopes this proposed rule change will provide SBA lenders with more flexibility and smaller businesses better access to credit.

The rule change is clearly being made in the spirit of making access to funds easier for borrowers, but lenders must consider the effects of such rule change. It’s important for lenders to realize, while the SBA is proposing more flexibility, the SBA still requires that the lender be prudent with their underwriting decisions. Since prudent lending can be difficult to define, lenders need to consider the risk carefully in making their decisions surrounding insurance requirements. For example, if you had a small loan that was used to purchase equipment and the equipment fully secured or nearly fully secured the loan, a prudent lender may require hazard insurance, even when they don’t do so conventionally.

Additionally, if the lender is relying upon its conventional policy to waive hazard insurance requirements, the lender must make sure such policy is a written policy. This way the lender can supply SBA with written support for why such a decision was made and meet the new standards that have been proposed.

It is important for SBA lenders to first consider their risk tolerance level before utilizing such flexibility, and to maintain their prudent lending process despite the new collateral hazard insurance flexibility. Also, it’s important to note that such new rule is just a proposal, and the SBA is still taking comments (deadline is December 27, 2022) on such proposals in hopes of implementing the most effective new regulations. SBA lenders can submit their comments through http://www.regulations.gov.

For more information regarding collateral hazard insurance and other SBA related diligence matters, contact the attorneys at Starfield & Smith, PC at 215-542-7070.