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”