Flood Insurance at Loan Closing?
By Jerod Moyer
Recently someone asked me what I thought was a very easy flood insurance question. The scenario played out like this:
The bank is going to make a loan secured by buildings located within a Special Flood Hazard Area (SFHA). The borrower does not have enough funds to pay for the flood insurance out of their own pocket. The bank told them not to worry that they would add the flood insurance premiums to the loan amount and disburse funds to the insurance agent at closing. The lender asked if this practice would satisfy the flood insurance requirements. I responded without hesitation that indeed it would and what would be better proof than the bank issuing the check and delivering it to the insurance agent.
Well, I was wrong. You see, flood insurance is required prior to making, increasing, renewing or extending any loan secured by improved property located within a SFHA. In the scenario above, flood insurance was not in place prior to closing; rather, it was put in place after closing. The loan was closed, a check was cut and then delivered to the flood insurance agent for payment. Therefore, the flood insurance requirements were not met.
Using the same scenario above the bank could have met the regulatory requirement by instructing the borrower to write a check to the flood insurance agent prior to loan closing. Obviously, the bank would have to then cover the check if the borrower was short on funds, depending on when the payment was made. The bank could then reimburse the borrower/cover the check with funds from the loan closing disbursement.
When it comes to flood insurance we need to remember that things that seem to make logical sense don't necessarily ensure compliance with the regulatory requirements.