[TheBank]

We have an application for a loan secured by an old home located in a SFHA where the borrower has a private flood insurance policy with the compliance aid statement. The loan purpose is to tear down the old home after origination and build a duplex. The applicant’s flood insurance agent has stated the borrower cannot purchase flood insurance for the duplex until the old home is demolished. Is this the case?

Current FDPA FAQ 24 seems to say the bank can wait to require flood insurance on a construction loan until when the building construction funds are disbursed. Adequate internal controls are required for this approach. Would it comply with FDPA if the lender had to approve the disbursement for the building construction as well as the pre-closing reviewer to ensure flood insurance is in place for the duplex prior to disbursement, but after the old home is demolished?

[kmeade]

Following

[rcooper]

Generally, when dealing with construction loans you can require flood insurance to be in place at origination or delay until the start of construction (and 30 days before disbursement). Proposed Interagency Flood Q&A addresses all of this and has some propsed changes to the existing Q&As that need to be considered. For example, if lender “… does not require the borrower to obtain flood insurance at loan origination, then it should have adequate internal controls in place at origination to ensure that the borrower obtains flood insurance no later than 30 days prior to disbursement of funds to the borrower.” (See Q&A 4 and 5 below). I’ve also pulled some other excerpts from the Proposed Q&As that I thought would be helpful.

As for what is considered adequate controls, that will likely differ depending on the institution. You need to ensure you have strong process that doesn’t allow room for exceptions with regards to this. A two line approval process seems necessary and you might also want to flag the system with a note, create a tickler XX (30+) days prior to disbursement to ensure insurance is in place, institute review forms for use prior to disbursement where the employee disbursing funds only does so after they receive the form with dual signatures and a copy of the insurance. These would all be ways to ensure you have an adequate internal controls to ensure the borrower obtains flood insurance as required.

Prposed “Construction #3” states:
Is a building in the course of construction that is located in an SFHA in which flood insurance is available under the Act eligible for coverage under an NFIP
policy?
Buildings in the course of construction that have yet to be walled and roofed are eligible for coverage except when construction has been halted for more than 90 days and/or if the lowest floor used for rating purposes is below the Base Flood Elevation (BFE)…

Although an NFIP policy may be purchased prior to the start of construction, as a practical matter, coverage under an NFIP policy is not effective until actual construction commences or when materials or supplies intended for use in such construction, alteration, or repair are contained in an enclosed building on the premises or adjacent to the premises.

Proposed “Construction 4” states:
When must a lender require the purchase of flood insurance for a loan secured by a building in the course of construction that is located in an SFHA in which
flood insurance is available?

…Alternatively, a lender may allow a borrower to defer the purchase of flood insurance until either a foundation slab has been poured and/or an EC has been issued or, if the building to be constructed will have its lowest floor below the Base Flood Elevation, when the building is walled and roofed. However, in order to comply with the Regulation,68 the lender must require the borrower to have flood insurance for the security property in place before the lender disburses funds to pay for building construction (except as necessary to pour the slab or perform preliminary site work, such as laying utilities, clearing brush, or the purchase and/or delivery of building materials). If the lender elects this approach and does not require the borrower to obtain flood insurance at loan origination, then it should have adequate internal controls in place at origination to ensure that the borrower obtains flood insurance no later than 30 days prior to disbursement of funds to the borrower. (See NFIP Flood Insurance Manual). (See also Q&A
Construction 5).

and Proposed “Construction #5” states:
CONSTRUCTION 5. Does the 30-day waiting period apply when the purchase of the flood insurance policy is deferred in connection with a construction loan?
Yes. Under the NFIP, a 30-day waiting period applies anytime a lender requires flood insurance not in connection with the making, increasing, renewing or extending of a designated loan. Therefore, a 30-day waiting period will apply if a lender allows a borrower to delay the purchase of flood insurance in connection with a construction loan. (NFIP Flood Insurance Manual). (See also Q&A Construction 4).

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