Loan to close on 4 lots owned free and clear for a builder to construct 4 spec homes. We would like to give the required notice and close as soon as possible without binder/policy in hand. Before construction takes place on the fourth lot, we will require flood insurance at that time. Is it acceptable to close without flood insurance but require a policy prior to construction on fourth lot?

The following is from the April edition of our newsletter. I think you'll find the answers to your questions in this.

Flood Insurance & Construction Loans
When it comes to construction loans, there are two options concerning the purchase of flood insurance:
1. Require flood insurance before closing the loan; or,
2. Delay the purchase of flood insurance until a slab is poured or an elevation certificate is issued.

This article will explain the complications and risks of the second approach.
We often hear that lenders want to delay the purchase of flood insurance for the “benefit” of the borrower. While this approach creates some extra complications, you can do this and remain in compliance. Before doing so; however, it’s important to realize the potential effects.

First, lenders often think they’re saving the borrowers some money. But it is important to remember that a lender’s job is to act in the best interest of the bank and its collateral. Additionally, this may result in anything but a convenience to your borrowers.

As you probably already realize, there is generally a 30-day waiting period before a flood insurance policy goes into effect. However, there is no waiting period for flood insurance that is purchased in connection with making, increasing, extending, or renewing a loan (i.e., a MIRE event). This allows a borrower the potential to apply and pay for the flood insurance premium so that you can have proof of the required flood insurance to close the loan.

There used to be an exception to the 30-day waiting period in scenarios where the lender determined that flood insurance was required but not in place. However, effective October 1, 2013, the NFIP changed their rules and a 30-day waiting period now applies anytime a lender is requiring flood insurance outside of a MIRE event. Therefore, a 30-day waiting period will apply if you allow the borrower to delay the purchase of flood insurance in connection with a construction loan. This seems to be contradicted by Interagency Flood Insurance Q&A #23, which states:

Does the 30-day waiting period apply when the purchase of the flood insurance policy is deferred in connection with a construction loan?
Answer: No. The NFIP will rely on an insurance agent’s representation on the application for flood insurance that the purchase of insurance has been properly deferred unless there is a loss during the first 30 days of the policy period. In that case, the NFIP will require documentation of the loan transaction, such as settlement papers, before adjusting the loss.

We’ve never seen anything that officially rescinded this Q&A, so one would expect it to still hold true. However, the Q&A simply wasn’t updated with the change in the NFIP’s policy in October 2013. This is just one of many things that complicate attempts to get flood insurance right. FEMA makes changes that directly impact creditors, but there’s no direct line of communication to those creditors. FEMA communicates with insurance agents, and you likely already know there is some risk in taking flood insurance advice from an agent.

If you’re not going to require flood insurance at the time of closing a construction loan you will have a 30-day wait (after the borrower applies for and provides payment for a flood insurance policy and the agent submits the information and payment to the NFIP) before the policy goes into effect. This means you may be faced with explaining to your borrower that you cannot disburse any more loan proceeds until the flood insurance policy goes into effect. Construction will likely need to be delayed during this waiting period, since funds can’t be advanced if you wish to remain in compliance. At the very least, you will absolutely want to make sure your borrowers understand this potential effect of not having the flood insurance in place at closing. Any “goodwill” you may have built up with the borrower by allowing them to delay the purchase of flood insurance may quickly be spent if you are unable to disburse funds down the road because there is a 30-day wait before their flood insurance becomes effective.

We’ve never been fans of allowing borrowers to delay purchasing flood insurance because of the additional monitoring burden that comes with it. Flood insurance is hard enough and takes enough manpower that we don’t understand taking on the additional, unnecessary responsibility of monitoring construction just to see when you have to require flood insurance. We know that some agents like to say they can’t write flood insurance prior to construction, but they CAN write it based on estimated elevation and the anticipated value. Don’t let them tell you differently.

If you’re allowing borrowers to delay the purchase of flood insurance on a construction loan, we feel you should reconsider that practice. It could make sense if construction won’t start right away. Otherwise, your intent may be good, but the effects may not be, for the bank or the borrower. We understand that you want to make your borrower happy; however, remember that you’re balancing the interests of the borrower(s) with those of the bank and you’re undoubtedly in the best position to enforce loan requirements before you make the loan.

Just to recap, if you delay the purchase of flood insurance, you should consider the following:
1. You will need to monitor the construction progress. This is an expense to you, the creditor. Once a slab is poured or an elevation certificate is issued, you cannot allow any more advances on the loan until adequate flood insurance is in place.
2. Understand there will be a 30-day wait after the borrower pays for the insurance and the agent completes the insurance application and submits it to the NFIP.
3. Realize that borrowers are normally cooperative prior to closing a loan. But typically, once the loan is closed, borrower cooperation can deteriorate. Asking them to bring you evidence of adequate flood insurance can be a tougher challenge and you’ve lost your “leverage”.
4. Understand the lender is taking on a risk of not having evidence of adequate insurance. Examiners will also review this process very closely.

It’s important to weigh these costs and risks to the bank with the possibly small savings to the borrower. Often times, they won’t pay very much in premiums before the slab is poured or the elevation certificate is issued.

Thank you for information - clears up many conflicting requirements I had researched.

We have been told by borrowers (in some instances) that they could not obtain flood insurance on a construction loan. Can flood insurance be obtained before construction has started?

Yes. See David Dickinson's post above dated 5/11/16. The borrower needs to push the agent to get the policy or find an agent who knows what (s)he is doing.

Many agents tell people they can't purchase flood insurance on a yet to be completed building. That's [censored]. I personally did it. Most agents just don't know or don't want to deal with it.

Similar question- construction of a structure in a flood zone.

Currently, we have a loan that is secured by land only located in flood zone A. Our borrowers would like to build a structure on this land. However, before they build they would like to remove the property from the flood zone so they do not have to obtain flood insurance. They have elevation certificate.

So, this is were I'm confused. Can they obtain a LOMA before construction with the elevation certificate they have? Or, once the structure is completed another elevation certificate will need to be done and then a LOMA can be submitted to FEMA?

A LOMA indicates the NFIP map is incorrect. It's not based on the elevation of the building but rather the incorrect map information. A LOMR demonstrates a property has been changed - typically by fill. If the map is wrong, the borrower should be able to get a LOMA before construction.

Actually, prior to construction, the best they can do is a CLOMR unless the property is eligible for a LOMA:

https://www.fema.gov/conditional-letter-map-revision

" A Conditional Letter of Map Revision (CLOMR) is FEMA's comment on a proposed project that would, upon construction, affect the hydrologic or hydraulic characteristics of a flooding source and thus result in the modification of the existing regulatory floodway, the effective Base Flood Elevations (BFEs), or the Special Flood Hazard Area (SFHA). The letter does not revise an effective NFIP map, it indicates whether the project, if built as proposed, would be recognized by FEMA. FEMA charges a fee for processing a CLOMR to recover the costs associated with the review. Building permits cannot be issued based on a CLOMR, because a CLOMR does not change the NFIP map.

Once a project has been completed, the community must request a revision to the Flood Insurance Rate Map (FIRM) to reflect the project. "As-built" certification and other data must be submitted to support the revision request."

A CLOMR will not exempt the loan for the flood hazard insurance requirements. If they are actually issued a LOMR after construction, the flood insurance premium will be fully refundable.

Follow up Questions:

Flood Determination at time of construction loan stated not in flood zone. For a HELOC 9 months later, flood determination states completed building is in flood zone. We were never notified of any change from 3rd party determination company.

It was originally a construction to perm loan. Is the switch from construction to perm considered a MIRE event to where we should have pulled another determination, or is this on the 3rd party company?

I'm terribly confused on where blame needs to be placed here, if any. The new HELOC is definitely MIRE, so we're fine there, but are we going to deal with regulatory issues here?

"Flood Determination at time of construction loan stated not in flood zone."

I would try to find out why the initial determination didn't put the new building in the flood zone but the one for the HELOC did. Was there a change in where the building was built?

"We were never notified of any change from 3rd party determination company."

Your 3rd party provider would notify you of map changes, not of new constructions.

"Is the switch from construction to perm considered a MIRE event to where we should have pulled another determination, or is this on the 3rd party company?"

Your initial determination should have put the building in a flood zone and flood insurance should have been required as soon as the pouring of slab or footing was made.