On the heels of a recent HUD audit on flood insurance, regulators put lenders on notice. They found 31,500 federally backed loans in flood zones without flood insurance, exposing lenders to more than $4.5 billion in risk. This news is a wake-up call to lenders to take a hard look at their flood insurance program and find the compliance gaps. By assessing current procedures and finding the gaps, lenders can limit the financial risks on flood properties and potentially eliminate significant fines of up to $2,000.
Step 1: Know the flood regulations
Lending in flood areas is risky business. That’s why it’s critical for lenders to understand the risk of holding noncompliant loans. If a borrower walks away from a property that has inadequate flood insurance, the lender pays the price in two ways: risk from borrower default and regulatory fines. For these reasons, it’s critical that lenders thoroughly understand the Federal Disaster Protection Act (FDPA) requirements as follows:
1. The loan (commercial or consumer) is secured by improved real estate or a mobile home that is affixed to a permanent foundation (security property)
2. The property securing the loan is located or will be in an SFHA as identified by FEMA
3. The community in which the property is located participates in the NFIP (National Flood Insurance Program)
Step 2: Communicate with your borrowers
How can you make sure your bases are covered? By law, lenders are required to let borrowers know how much flood insurance they need when originating a loan. Once the lender receives documentation of flood insurance, it is the lender’s obligation to make sure the flood policy is current and to communicate with borrowers when insurance is inadequate or has lapsed.
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Step 3: Set your priorities: monitor and enforce
An effective flood insurance program includes lenders who train staff on regulations (which loans require flood insurance and how much) and on compliance. A process to monitor lapses in flood insurance coverage and to initiate force placed insurance when requires are key to avoiding financial risk and costly penalties.
1. Inform borrowers of flood insurance requirements. As a lender, you must provide a written notice to the borrower including:
1) acknowledgment that the property is located in an SFHA
2) a description of flood insurance requirements
3) availability of NFIP and/or private insurance coverage
4) availability of federal disaster relief
2. Keep borrowers aware of changes. Make applicants aware of upcoming changes to flood insurance requirements resulting from community map changes
3. Enforce federal flood insurance requirements. To avoid costly fines for noncompliance. lenders can set up an iron-clad process to make sure that any loan that requires flood insurance has it, and that force placement is initiated when policies lapse.