Making BSA a Team Effort 

Regardless of the size or level of sophistication of your bank, there must be a Bank Secrecy Act (“BSA”) and Anti Money Laundering (“AML”) compliance program in place.   Oftentimes, for smaller banks, this can be a problem due to limited resources.   The costs associated with training, software monitoring and ongoing review of customer activity can be daunting.  Of course the costs associated with noncompliance can be even worse.  Enforcements actions, and orders to look back at two years’ worth of transactions are typical in situations where examiners find an ineffective BSA system.   One of the best ways to maintain a strong BSA/AML compliance program while keeping costs down is making the program a team effort.   

Four Pillars of a BSA/AML Program  

For any BSA compliance program there are four elements that must exist at a minimum: 

·         Policies and procedures that establish internal controls – procedures should be established that detail the minimum requirements for obtaining information from a customer before opening an account.  In addition, policies and procedures should detail the rules for which accounts will and will not be allowed at the Bank.

·         Training- every staff member, member of management and every Board member should receive training on an annual basis.  This is one of the few areas in compliance where the training requirement is actually written into the regulations.   

·         A BSA Compliance Officer – the BSA Officer must be appointed by the Board on an annual basis and should have all of the necessary training and experience to perform the duties of this role at the institution.   

·         Independent testing- there should be an annual audit of the overall effectiveness of the BSA program on an annual basis.  The results of the audit should be reported to the Board and areas of concern should be tracked and mitigated.      

In addition to the above, every financial institution should perform a risk assessment for both BSA and OFAC on an annual basis.  The risk assessment should detail information about products being offered, the customers that are being maintained, information about the geography surrounding the branches of the institution and the steps that have been taken to mitigate risk.    Finally, although it is not an actual regulatory requirement, no self-respecting institution attempts a BSA program these days without some sort of aggregation and monitoring software.    

KYC-The Heart of the Program

Notwithstanding the specifics mentioned above, the true beating heart of any effective BSA/AML program is the system of knowing your customers (“KYC”).  Complete information on who your customers are and what they do to make money is the key to understanding whether or not activity is suspicious.    This point was recently reinforced by the FDIC when they released guidance on bank services in Financial Letter 5-2015.  The point of the guidance was to encourage banks to develop systems for assessing the risks associated with individual customers.     In this guidance the FDIC notes that:

“Accordingly, the FDIC encourages institutions to take a risk-based approach in assessing individual customer relationships rather than declining to provide banking services to entire categories of customers, without regard to the risks presented by an individual customer or the financial institution’s ability to manage the risk” [1]

The best way to develop an understanding of the level of risk posed by an individual customer is to know the nature of the business and the clients of your customer.  A good rule of thumb to remember is that if staff at the Bank cannot fully understand and document the business, then the risk to the bank is too high and the customer should not maintain an account.   Information about the particular industry of your customer is also key for comparison purposes.  A good source of information is the NAICS system.   In any event, making the point to all bank staff that all information about a customer is vital to a good first step to improving the effectiveness of your KYC.  

Getting Bank Staff involved in KYC

One area that often gets overlooked in BSA and marketing programs is what an excellent source of information operations staff can be.  With a little training and common use of information, a great deal of advantage can be gained.   Contact with a customer does not have to be an interrogation.   Good customer service generally entails, cross-selling and giving good information about services that your institution offers.  By encouraging staff to talk with customers about their plans and uses of money a great deal of information can be obtained.  Often times, it is the operations staff that have ongoing contact with customers.  “Deputize” your operations staff to be your eyes and ears.  Make sure that these folks keep a record of conversations that they have with customers and the information that might be gleaned from general conversations.  Finding out that a customer is thinking of opening a second branch of their business is great information for BSA, but also a potential additional loans opportunity. 

Lending Staff Your Secret Weapon

One of the best sources of information and KYC that is unfortunately under-utilized are loan officers.   When putting together credit memos for potential loan deals, the loan officer follows a similar approach to the KYC that a BSA Officer should do.   The sources and uses of funds, expected outcomes and future plans of the customer are all bits of information that should be considered by the loan officer.   In addition, for anyone who is asking the Bank to lend their customer money, an onsite visit is a must.  Voila!  All of the information that a BSA Officer would need to know about a customer and make a determination about whether or not activity is suspicious is available at the fingertips of the loan officer. 

All Together Now   

Oftentimes, the hardest part of building a team effort around compliance is misunderstanding.  Compliance regulations often get cast as impediments to business and are therefore often viewed as work to be avoided.   However, BSA/AML is actually a global and vibrant part of banking.  It is an important part of the fight against global terrorism drug dealing and human trafficking.  There is ample evidence that the people at FINCEN actually do read and act on Suspicious Activity Reports.   In May, 2015 FINCEN published a news release detailing some of the more significant cases that had been filed as a result of SARs.  Help staff understand that what they are doing when they are working with the BSA program is actually helping a much larger effort.   This understanding will increase the interest in the program and help staff fully engaged.    

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[1] FIL 5-2015

Are You Ready for a Fair Lending Review?

Introduction

You have just received the news; as part of the upcoming compliance examination, the regulators will be performing a fair lending review.  No problem, right?  Well, maybe just a slight problem; such as you have NO IDEA what a fair lending review is and what it will take to pass!   Well, fear not, there are some quick diagnostics that you can use to determine how bad it might be!  

First Things First

There is no one fair lending law or regulation.  In fact, there are several laws and regulations that come together to make up the components of a fair lending examination.  These laws and rules include:

·         Regulation B (Equal Credit Opportunity)

·         Regulation Z (Advertising)

·         Regulation DD (Advertising)  

·         UDAAP  (Unfair Deceptive Abusive Practices)

·         The Community Reinvestment Act

·         Individual State laws

The examiners will use a combination of these rules and laws to make an overall determination about your Bank’s compliance with Fair Lending. 

A Quick Check up

If you have not already done so, now is a good time to ask yourself a series of questions that should help you determine your overall level of readiness for the Fair Lending examination

1.       Has your credit policy been reviewed and approved by the Board in the Last 12 Months?  If the answer to this question is no, there are potential fair lending problems.  One of the things that examiners will review is whether or not the Board keeps its credit policies up to date and in tune with the values of the Board.  In addition, the credit policy should reflect  the goals in the Bank’s strategic plan

2.       Is there a secondary review process for credit decisions?  Examiners will review the process by which credit decision receive a secondary opinion.  In particular, the examiner will want to make sure that there is documentation of exceptions to policy and a more intense review of loan decisions that are “close calls”.  The lack of a secondary review process can, and often does, lead to a negative finding.  

3.       Does Your Advertising Use People as subjects?  Many of our banks use testimonials of customers in their advertisements.  And while this is an effective means of advertising, it is also fraught with danger!  If your bank uses advertising that includes pictures of people, then the pictures should reflect the diversity of the surrounding community.  Anything less could be seen as discouragement for the groups of people who are not represented in the advertisements. 

4.       Does your Compliance Department Test Adverse Actions for Reg. B?  Adverse actions notices will always be tested in a fair lending examination.  Many of the tests in this area are subtle and require experience.  For example, when a loan is closed for lack of sufficient information, examiners may review approved loans that took significant time to close and compare the efforts that the loan staff put forth in both cases to ensure that discouragement did not take place. 

5.       Does your Bank keep a record of exceptions to policy for loans?  One of the key areas that will be reviewed in a fair lending examination is the Bank’s review and documentation of exceptions to loan policy.  All banks make exceptions, but documenting the business reasons for the exception is critical.  Without clear records of the reasons for exceptions that Board will be left to try to explain similarly situated borrowers that had divergent loan results. 

6.       Does your bank have a well-defined process for tracking and responding to complaints?    Consumer complaints are an invaluable source of feedback from your local assessment area.  By making sure that each compliant is researched and receives a response, a Bank can get a clear picture of how it is perceived in its community and can address what often times are misunderstandings.  This has become an area of focus in recent consumer examinations.  

7.       Has there been fair lending training for all staff that has direct public contact in the last 12 months?  Since fair lending is a topic that is complex and subtle, it is a best practice to ensure that all staff that have contact with the public receive at least a refresher course on an annual basis. 

8.       Has anyone at the Bank done a periodic comparison of loans granted versus declined?  One of the most important and potentially devastating reviews that examiners can perform during a fair lending audit is a regression analysis of similarly situated approved versus declined loans.   It is an excellent idea to have the compliance department compared declined to approve loans on a regular basis to ensure that there is symmetry in credit decisions.

9.       Has the credit scoring system been independently tested for validity?  Most of our banks used an established credit scoring system which is good for consistency sake.  However, it is a best practice to ensure that the credit scoring system is periodically validated.  Many banks forget to ask for information about validation of the system.  Often times, examiners ask for this information. 

10.   Is there a process for reviewing the Bank's outreach to its local community?   As part of the ongoing marketing or CRA program, does the Bank make a point of identifying the various members of its community and make an effort at outreach?   Is there a local Hispanic chamber of commerce or other special interest group within the assessment area?   If so, does the Bank make an effort to reach out to these groups? 

Are you ready?

The preceding list is not all inclusive, but in getting the answers to these questions, you can start to understand whether or not you are ready for an upcoming Fair Lending examination

Keeping Up with the Rising Tide- Flood Insurance Changes are Coming- A Three Part Series

Part Three:  Forced Placed Insurance       

Over the past several years, the contours of the flood insurance rules have experienced significant changes.   Both the Biggert Waters Act and the Homeowners Flood Insurance Affordability Act (“HFIAA”) have introduced long sought changes to the way flood insurance will be administrated.   As always, with changes to regulations, there are many questions about how the changes will affect the financial institutions that make loans with collateral in a flood zone.  This series will explain the three most recent changes.    

Force Placing of Flood Insurance    

One of the areas of the flood insurance rules that often causes confusion are the rules for force-placing flood insurance.  Briefly, the rule is that in the event that flood insurance is required for a loan, and the insurance policy either lapses or is insufficient, the lending institution is supposed to notify the customer of the problem and give 45 days for a response.  After 45 days pass, if the borrower has not corrected the problem, then the lending institution must obtain flood insurance and the charge the customer.    This process is commonly called force-placing flood insurance.  

While this rule may seem straightforward, there have been several questions that have been left open in this process.  For example, when is a flood insurance policy considered lapsed?  When the lending institution obtains flood insurance what is the date that the new policy starts and how much can the customer be charged?  What if the customer get his/her own flood policy after a policy has been forced placed?   The new rules are designed to answer most of these questions.  

When Does a Policy Lapse

Often, the first issue that must be addressed with the area of force placed flood insurance is the question of when the policy in place actually lapses.  Part of the confusion is caused by the fact that flood insurance policies generally allow a 30 day grace period from the expiration date for the customer to reinstate the policy.   So is the lapse date the expiration date or 30 days later?   The new rules address this question directly.  For purposes of the rule, the lapse date is the date that the policy expires or is cancelled by the insurance company.    This is important for the lending institution because they may charge the customer for insurance as of the lapse date.  

Notification Requirements

Probably one of the strangest areas of the flood insurance rules is the notification requirement.  The basic rule is that once a lender is aware that a flood insurance policy has expired or is insufficient[1], they must notify the borrower and give them 45 days to purchase insurance in the proper amount.   The question is often asked, if flood insurance policies give a 30 day grace period after expiration and lender has to wait 45 days to obtain new insurance, isn’t there a 15 day gap?  Yes, there is a gap[2].  The new rules do not close this gap, but they do allow the lender some relief.  When the lender obtains a new policy on the 45th day from expiration of the policy or notice to the borrower, the premiums can be charged back to the date of the notice.   In other words even if the policy is purchased on the 45 day after a notice, the premium can be charged back to the date of the notice.   

The question of whether or not a lender can give notice to the customer earlier so that the 45 day notice and the end of the grace period of a policy coincide is addressed.  The answer is clearly NO!  You can notify the customer earlier, but that will not change the 45 day waiting period before a new policy is obtained.  The statutory requirement is that the force placed policy will be purchased on the 46^th day after notice has been given.  [3]

Actual Force Placed Date

One area that the new rules address is the actual date that a lender can force place insurance.  Although the 45 day waiting period from the date of expiration still exists, this does not mean that a lender has to wait to force place the insurance.  Under the new rules, the lender may force place insurance on the day the insurance lapses[4].  In the event that the borrower does not obtain their own insurance, the lender can charge the premiums starting the day the policy lapsed. 

There is one caveat here though.  If the customer buys a policy during the 45 day period from the time of the notice of the lapsed policy, there may be overlapping policies.   Any premiums for the forced placed insurance that overlap with the customers’ policy must be refunded.  

What is Sufficient Evidence of a Policy?

Another area addressed in the rules is the issue of sufficient evidence of an insurance policy.  Over the past few years, financial institutions have been cited for inadequate evidence of insurance policies when they presented binder pages or other documents as evidence of insurance.   The new rules address this question directly: 

“Sufficient documentation consists of an insurance policy declarations page that includes the existing flood insurance policy number and the identity of and contact information for the insurance company or its agent. This information is all that is required under Biggert-Waters for an insurance policy declarations page to be considered sufficient evidence of a borrower’s flood insurance coverage, and the Agencies decline to require additional information”

Putting it all together

The most recent publication from the FFIEC on flood insurance rules covers three main areas:

1.       Exemptions from flood insurance

2.       The escrow rule

3.       Forced placed insurance  

A quick review of each of the new rules:  

Exemptions from flood insurance:  The rules for structures that are detached from a residence will change.   If the property that is pledged as collateral is in a flood zone, then the flood insurance rules apply.   Insurance is required only for each structure that serves as a residence on the property at the time the loan is made.  This rule applies regardless of the purpose of the loan.  This rule does NOT apply to structures that are used for commercial, agricultural or other business purposes.  In summary, there is no longer a need to get insurance on that random pole barn or chicken coop. 

Escrow rules:  If your institution has less than $1 billion in assets, then it is unlikely that the escrow rule will apply; unless you regularly insist on escrow for insurance and taxes, or state law requires escrow.  The easiest way to tell if this rule applies to your institution is to determine whether or not you have well established policies and procedures for instituting escrow.  In other words, if escrow is something that your bank has been doing for some time, it is likely that the rule will apply.   If the rule does apply, on January 1, 2016, your institution will need to offer the escrow option to all existing loan accounts with flood insurance.  In addition, for all loans made, increased, renewed or extended after January 1, 2016, payments for flood insurance will be included in escrow. 

Forced placed insurance:   Under the new rules, a policy is lapsed on the date it is cancelled.  That is, the grace period of a flood insurance policy does not extend the lapse date for purposes of force-placing insurance.  Even though the 45 day rule still applies, bank may force place insurance on the day a policy lapses or the bank finds that the amount of insurance is deficient.   Premiums that are paid for forced placed insurance can be charged starting at the day of the lapse.  However, any premiums that are charged for overlapping insurance must be refunded to the consumer.  

 

We believe that these rules will ultimately make getting flood insurance right easier. 

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[1] This includes a situation where a lender recently discovered that a property was in a flood zone, or where a flood map changed

[2] But see below- actual forced date

[3] See Interagency questions and answer of flood insurance 64 for a general discussion

[4] Or the day the lender finds out that insurance is insufficient

Keeping Up with the Rising Tide- Flood Insurance Changes are Coming- A Three Part Series

Part TWO:  Rules for Establishing Escrow for Flood Insurance     

Over the past several years, the contours of the flood insurance rules have experienced significant changes.   Both the Biggert Waters Act and the Homeowners Flood Insurance Affordability Act (“HFIAA”) have introduced long sought changes to the way flood insurance will be administrated.   As always, with changes to regulations, there are many questions about how the changes will affect the financial institutions that make loans with collateral in a flood zone.  This series will explain the three most recent changes.    

Escrow may be Required for Loans in a Flood Zone.  

Under the new rules,

A regulated lending institution, or a servicer acting on behalf of a regulated lending institution, [is required] to escrow all premiums and fees for flood insurance required for loans secured by residential improved real estate or a mobile home unless the loan or the lending institution qualifies for one of the statutory exceptions[1]

 

As of January 1, 2016, this rule will apply to any consumer purpose loan that is made increased, renewed or extended.   The timing of the escrow payments will need to be set up to match the monthly payments for principal and interest

Step One:  Does the Escrow Rule Apply?  

When we say Escrow MAY be required, the first place to start with are the exceptions to the rule.  The fist exception is the small lender exception.  Small lenders are those banks that had less than $1 billion in assets on December 31, 2012 and who have not had more than $1 billion on December 31, for two straight Years.  If this formula sounds somewhat familiar, it should.  This is similar to the formula used in the Community Reinvestment Act to determine whether banks are small, intermediate or large under the rules.  The FFIEC noted that they wanted the determination to match the CRA scenario.  

However, it should be noted that this exception has two exceptions itself.  First, if a loan had an escrow requirement as the result of state or federal law, then the escrow cannot now be avoided.  If there was an escrow in place, it should not be removed by the new rules.  Second, in the case where a bank routinely requires escrow on real estate secured loans, the small lender exception will not apply.  The comments in this area are straight forward, in cases when banks have been requiring escrow, the infrastructure already exists to initiate and administrate the escrow payments.  

One distinction should be made here, there are cases, where borrowers have requested escrow and a bank has provided it.  These cases, do NOT count as routinely requiring escrow and so, a bank that simply allowed flood insurance payments to be included in escrow as an accommodation to its customers wishes, could still claim the small lender exception.  

So, if you are an institution that:

·         Is less than $1 Billion in assets,

·         Has no loans in a flood zone that currently have escrow that was required by state of federal law,

·         And do not routinely require escrow for real estate secured loans,

The escrow rule will not apply to you until you meet that $1billion mark.   However, we suggest that you read on; change is inevitable, and the $1 Billion mark is not as far away as you might think.  

Step Two:  Does the Escrow rule apply to THIS loan? 

In the event that you have determined that the escrow rule will apply to your bank in general, there still may be reasons that the rule may not apply to a specific loan.   Business purpose loans are an exception to the rule that an escrow must be established.  In this case, if the loan is primarily for a business purpose, escrow is not required.    

The other exceptions are as follows:  

·         Loans that are in a subordinate position to a senior lien secured by the same property for which flood insurance is being provided.  Here, there is already flood insurance on the property. [2]

·         Loans secured by residential improved real estate or a mobile home that is part of a condominium, cooperative, or other project development, provided certain conditions are met.  The conditions that must be met are essentially, that the amount of insurance has to be sufficient.  

·         Loans that are secured by residential improved real estate or a mobile home that is used as collateral for a business purpose.  Commercial loans do NOT have an escrow requirement. 

·         Home equity lines of credit.  These loans do not necessary have regular payments and are not subject to escrow. 

·         Nonperforming loans.  These are mortgages that would be in the loss mitigation process.  The escrow requirement will only apply if the loan is reinstated. 

·         Loans with terms not longer than 12 months.  For example, a construction loan that gets extended.  

If the loan that you are making, increasing, renewing or extending falls into any of the above categories, there is no escrow requirement on the specific loan, even if there is an overall escrow requirement at your bank.   

In the event that the escrow does or will soon apply to your bank, there a couple of things that require immediate attention.  First, when setting up escrow payments for flood insurance, the timing of the flood insurance payments should match the taxes and hazard insurance payments.  Also, when the escrow rule applies and a loan is made, increased, renewed or extended, a notice of the escrow requirements should be sent as early on in the loan process as practicable.  Finally, if the escrow rule applies to your bank, there is a requirement, that escrow should be offered to all borrowers for whom there is not an exception.  Your bank would be required to notify flood insurance customers of the option to include payments in escrow.  This notice would be required even for borrowers who had previously waived escrow. 

Flood Loan Land Mines

The new rules establish a couple of areas that can cause a nasty surprise without proper monitoring.   First, remember that the escrow rule is based upon the size and escrow practices of your bank.  In the event that the bank grows over $1 Billion, or institutes a practice of requiring escrows for home mortgages, the flood escrow rule may kick in.  We recommend that as part of your compliance monitoring, you look for signs that the rule may soon apply. 

A second area where a flood insurance escrow situation might spring to life, is one where a change of circumstances removes the exception.  For example, in the case of a junior lien.  When the loan was made, there was no need  for an escrow because that was a superior lien and flood insurance was in place.  There was no need to continue to monitor this loan.  However, in the event that the bank finds out that there has been a change, e.g. the first has been paid off,  the escrow requirement may spring to life.  This is a training issue for loan staff.  

Finally, non-performing loans are exempt from the escrow requirement for the time period that they are nonperforming.  In the event that the loan is brought current or modified through agreement and brought current, the escrow requirement is reinstated.  

 

In Part Three of this Series on Flood Insurance we will discuss forced placed flood insurance and bringing the flood rules all together. 

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[1] FFIEC Final Rule on Flood Insurance  

[2] But, see the discussion on “flood land mines” 

Keeping Up with the Rising Tide- Flood Insurance Changes are Coming- A Three Part Series

Part One:  The Detached Structure Exemption  

Over the past several years, the contours of the flood insurance rules have experienced significant changes.   Both the Biggert Waters Act and the Homeowners Flood Insurance Affordability Act (“HFIAA”) have introduced long sought changes to the way flood insurance will be administrated.   As always, with changes to regulations, there are many questions about how the changes will affect the financial institutions that make loans with collateral in a flood zone.  This series will explain the three most recent changes.    

Non Residential detached structures will NOT require flood insurance.  

This is a big change.  Since the inception of the flood insurance program, one of the rules that has vexed loan officers was the need to get insurance on that proverbial tool shed or pole barn in the yard that was worthless.  You know the routine, I am sure.  The examiner cites your bank for failure to get insurance because there is a structure in the back of the property.  “But the property is worthless”, you say; alas, the rule was “three walls and a ceiling make it insurable”.  Well, this is no longer the case!   The new rules exempt from coverage any nonresidential structures that are detached from the collateral property.   BEWARE: This exemption does not apply to commercial or agricultural structures.  There are several key points to remember when making the determination not to cover structures with flood insurance.  

Collateral: 

The first thing to remember is that exemption applies regardless of the purpose of the loan.  Whether or not the reason for the loan is commercial or for personal reasons the exemption will apply as long as the collateral being pledged is a residence.  So, if the borrowers are pledging their home to start their own business, the detached structure exemption will apply.   ^[1]  

Residential Property 

The next thing to consider is the definition of what is “residential property”.  There was quite a bit of discussion about what this means.  When the proposed rules were published there were advocates that wanted the definition to include “residential improved property” which would include all of the structures on a residential property.  The agencies made it clear that this definition is too broad because it might have the effect of exempting commercial or agriculture structures on a property.    For purposes of the flood insurance rule, the agencies decided to combine the definitions used by HUD and Regulation Z.    The HUD definition of a residence is:

Residential property means a dwelling unit, common areas, building exterior surfaces, and any surrounding land, including outbuildings, fences and play equipment affixed to the land, belonging to an owner and available for use by residents, but not including land used for agricultural, commercial, industrial or other non-residential purposes, and not including paint on the pavement of parking lots, garages, or roadways.” [2]

 

 

While Regulation Z’s definition “residential property” specifies that: 

“A structure that is part of a residential property” refers to a structure used primarily for personal, family, or household purposes, and not used primarily for agricultural, commercial, industrial, or other business purposes”[3]

When you put these two definitions together, the term residential property means that if a structure is used as a residence, it must have flood insurance.   A garage that has been converted into a living unit would fit this definition.  At the end of the day, the final call is left to the lender, but if there are people living in the structure at the time the loan is made, the structure is residential.  The rule also goes on to consider the case of multi-family dwelling units: these are considered residential properties for the purpose of the flood rules. [4] 

What if a building is both commercial and residential?  For the exemption to apply the structure has to be more than 50 percent residential.  Remember, when we are talking about the exemption, we are talking about the other structures on the property.  The residential structure itself must have flood insurance.   

Structures with value

Suppose you have determined that a detached structure is not residential and is exempt, but the structure has significant value?      

“The Agencies believe detached structures used for commercial, agricultural, or other business purposes should be protected adequately by flood insurance as collateral given their value to the borrower and lender, and should not be covered by the detached structures exemption^[5] “

Keep in mind then, that if there is something like a greenhouse on residential property, it is not a residential structure and is technically exempt.  However, safe and sound banking principles may require that this structure should be covered with flood insurance.  Be careful when using the exemption.    

Detached

The next issue to consider is whether the structure is detached.   There have been several versions of what detached meant in the past.  The new rules make it clear that detached is just what it sounds like.  The structure cannot be attached to the residence in any way.   There can be no breezeway or walkway or any other connection to the residence.  If so, the structure is part of the residence and needs insurance.  If the structure is detached and it does not serve as a residence, there is no need to get flood insurance [6]

Serve as Residence

The final area to consider for the exemption is whether or not a structure serves as a residence.  There was a great deal of confusion and comment about the definition of “serve as a residence”.  In the end, the rule uses the IRS definition:

“IRS regulations provide that “[w]hether property is a residence shall be determined based on all the facts and circumstances, including the good faith of the taxpayer. A residence generally includes a house, condominium, mobile home, boat, or house trailer that contains sleeping space and toilet and cooking facilities. A residence does not include personal property, such as furniture or a television that, in accordance with the applicable local law, is not a fixture.” [7]

 

Ultimately, it is up to the lender to make the determination about whether or not a structure serves as a residence.  There is no formula other than the “sniff” test.  If people are living in the structure it IS a residence for flood insurance purposes.  The good news here is that this is a onetime determination.  If at the time the loan is made, there is no one living in the structure and it did not appear to be a residence, it would not require flood insurance.  There is no duty to continue to check to see whether or not the status of the property has changed.  

In summary, there several steps to take when determining whether or not the nonresidential structure exemptions applies.  Remember, this exemptions does not apply for commercial and agricultural structures.  Steps for determining the flood insurance exemption

Step One: Real property is pledged as collateral

Step Two:  Determine if the property is in a flood zone

Step Three: Determine if the property being pledged is a residence or serves as a residence.  If No, the exemption does not apply.  If yes, continue to step Four

Step Four:  Assess whether or not there are additional structures on the property. 

Step Five:  Determine whether additional structures are detached

Step Six: Determine whether detached structures serve as a residence.  If No, then no flood insurance is required for these structures.  If yes, additional flood insurance is required.

Step Seven:  Calculate the proper amount of insurance

Best practice:  Determine whether detached structures have significant commercial or agricultural value- additional insurance may be required.  

 

Part two of this Series will cover forced-placed flood insurance rules 

 

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[1] The property could later serve as a residence, but if it does not at the time the loan is made, then the exemption applies

[2] 24 CFR 35.110.

[3] See 12 CFR 1026.1(c)(1).

[4] See Interagency Questions and Answers Regarding Flood insurance #51

[5] FIL-32-2015

[6] Although, see above structures with value

[7] See 26 CFR 1.163-10T(p)(3)(ii).