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To escrow, or not to escrow: new flood insurance rules.

ACCORDING TO THE FEDERAL EMERGENCY MANAGEMENT AGENCY (FEMA), "Floods are the most common and costly natural disaster in the United States."

In 2011, homeowners throughout the country painfully learned that lesson as they endured overwhelming flooding that resulted in billions of dollars' worth of damage to their properties. That year, Hurricane Irene alone is estimated to have caused between $7 billion and $10 billion in losses, mostly from flooding.

These significant losses translate to a significant volume of flood insurance claims. For example, in 2005 Hurricane Katrina resulted in claim payments of $16.2 billion from the National Flood Insurance Program (NFIP), making it the most expensive flood since the NFIP began in 1968.

These dramatic statistics serve as a harsh reminder to lenders about the importance of understanding and properly complying with federal flood insurance laws and regulations.

On July 21, 2015, the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (OCC), the Farm Credit Administration (FCA) and the National Credit Union Administration (NCUA) jointly published a final rule to implement new flood insurance requirements enacted in the Biggert-Waters Flood Insurance Reform Act (BWA) of 2012 and the Homeowner Flood Insurance Affordability Act (HFIAA) of 2014.

And like most legislation, it is not completely clear what the effect on lenders and servicers will be--but it will certainly require them to reconsider how they manage flood issues moving forward.

To ensure they are compliant with the new rules, banks are required to:

* identify for borrowers the initial payment and all monthly payments to the escrow account;

* provide borrowers with an escrow account statement;

* review the escrow account annually to determine if any changes must be made (if the insurance costs or taxes increase or decrease);

* provide the borrower with an annual escrow account statement; and

* correct any errors that are made in escrow calculations, adjust for these errors and notify the borrower of changes that have been made.

The new regulations added an additional layer of requirements for servicers, and some new deadlines are coming up this year regarding escrow accounts. These requirements include:

* Servicers are required to offer and make available the option to escrow to borrowers (this excludes exempted servicers--those with assets of less than $1 billion--and loans already escrowing for flood insurance;

* Escrow notices must be delivered to borrowers by June 30, 2016;

* If exempted status changes, notice must be delivered by Sept. 30 on the first calendar year of the status change;

* Notices can be combined with other disclosures or sent separately; and

* If a borrower requests escrow, this must begin as soon as reasonably practicable.

The final rule exempts from the flood insurance escrow requirement the following:

* financial institutions with total assets of less than $1 billion (as of Dec. 31 of either of the two prior calendar years);

* any institution that, as of July 6, 2012, was not required under federal or state law to deposit taxes, insurance premiums, fees or any other charges in an escrow account for the entire term of any loan secured by residential improved real estate or a mobile home;

* loans with a subordinate position to a senior lien secured by the same property for which flood insurance is being provided;

* loans secured by residential improved real estate or a mobile home that is part of a condominium, cooperative or other project development when covered by a flood insurance policy that 1) meets the mandatory flood insurance purchase requirement, 2) is provided by the condominium association, cooperative, homeowners association or other applicable group, and 3) the premium for which is paid by the condominium association, cooperative, homeowners association or other applicable group as a common expense;

* loans secured by residential improved real estate or a mobile home that is used as collateral for a business, commercial or agricultural purpose;

* home-equity lines of credit;

* nonperforming loans, which the regulation defines as a loan that is 90 or more days past due and remains nonperforming until it is permanently modified or until the entire amount past due--including principal, accrued interest and penalty interest incurred as the result of past due status--is collected or otherwise discharged in full; and

* loans with terms of 12 months or less.

While these new amendments are intended to help borrowers by ensuring they make insurance payments that are included in escrow, they significantly increase the amount of work for banks that originate loans.

The Federal Reserve suggests that banks establish periodic reviews of escrow accounts, develop training for escrow account staff, update and review applications that calculate escrow to ensure they are correct, and create internal compliance reviews and audits of escrow accounts. These steps will help ensure that banks are compliant and that they stay current with any changes.

Escrow accounts protect lenders and borrowers

Escrow accounts are a mortgage requirement to ensure that a lender's claim on the value of the home is protected. Escrow funds pay for homeowners insurance, property taxes and flood insurance.

All of these must be paid to retain ownership of the property or will pay off if something happens to the homeowner or the home. Although the escrow amounts included as part of a mortgage payment make it easy for the homeowner to ensure taxes and insurance are paid, the items paid through the escrow are based on the requirements of the mortgage lender.

Most people find that it is easiest on their pocketbooks to pay their taxes and insurance on a monthly basis, so they welcome escrow accounts. It takes an extremely disciplined person to remember to set aside money every month so that there's enough remaining for them to pay those bills when they come due every year. And it is all too easy to dip into those funds to pay other bills if the money is sitting in your bank account.

The new rule covers all loans secured by residential improved (updated) real estate or mobile homes that experience a triggering event (making, increasing, renewing or extending the loan) after Jan. 1,2016. A lender must escrow all premiums and fees for flood insurance, with some exceptions. This is a major change from the prior flood insurance regulations that required escrowing those amounts only if the lender also required the escrow of other amounts (usually for taxes or insurance).

Under the final rule, flood insurance is no longer required on structures that are part of a residential property but are detached from the primary residential structure and do not serve as a residence--such as a tool shed or pool house. Previously, detached nonresidential structures had to be insured separately from dwellings (except for detached garages that were covered under dwelling policies up to 10 percent of the policy amount).

According to the final rule, 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. In situations where certain structures are used for both residential and business purposes, the exemption applies only to structures with a primary residential purpose. A structure is detached if it stands alone, meaning it is not joined by any structural connection to the residential structure. Furthermore, the detached structure may not serve as a residence.

Because the lender is in the best position to consider all the facts and circumstances regarding the detached structure, the final rule requires lenders to consider the actual and intended use of a structure and to also determine in good faith if the structure serves as a residence.

While the rule indicates that structures can vary greatly in terms of size, value, purpose and facilities, it explains that a structure could be considered a residence if it includes bedroom(s), bathroom(s) or kitchen facilities. The status of a detached structure must be re-examined upon a qualifying triggering event, such as making, increasing, renewing and/or extending a loan.

Although detached structures are exempt from the mandatory purchase of flood insurance, lenders may nevertheless require flood insurance on a detached structure to protect the collateral securing the mortgage.

The new rule also states that the escrow provisions of the Real Estate Settlement Procedures Act (RESPA) apply to flood insurance escrows if the loan is subject to RESPA, which applies to federally related mortgage loans. The escrow provisions of RESPA generally limit the amount that may be maintained in escrow accounts, and they require escrow account statements. The rule also requires lenders to provide the escrow notice for any excepted loan that could lose its exemption during the term of the loan.

As a general rule, if a lender or its servicer determines during the term of a loan covered by this rule that an exception does not apply, the lender or its servicer shall require the escrow of all flood insurance premiums and fees as soon as reasonably practicable.

A lender may charge the borrower for the costs of force-placed coverage beginning on the date in which the borrower's previous coverage lapsed or did not provide sufficient coverage. A lender must terminate any force-placed insurance within 30 days of receipt of confirmation of sufficient existing coverage, and must refund to the borrower any premium and related fees charged during overlapping coverage. This may require lenders to bear the costs of some force-placed insurance related to periods when the borrower has sufficient insurance but force-placed coverage is also in effect.

A borrower can demonstrate sufficient coverage by providing a declarations page that includes the existing flood insurance policy number and the identity of and contact information for the insurance company or its agent.

Unlike in the context of escrow accounts established for hazard insurance under RESPA Regulation X, a regulated lender has no obligation under federal flood law to advance funds to pay for mandatory flood insurance premiums in lieu of force-placing insurance.

How to stay compliant

To facilitate compliance with this new rule, LERETA has updated the Notice of Special Flood Hazards to notify the borrower of the escrow requirements.

According to the language of the new rule, flood insurance coverage under the NFIP may be purchased through an insurance agent who will obtain the policy either directly through the NFIP or through an insurance company that participates in the NFIP.

Flood insurance that provides the same level of coverage as a standard flood insurance policy under the NFIP may be available from private insurers that do not participate in the NFIP. You should compare the flood insurance coverage, deductibles, exclusions, conditions and premiums associated with flood insurance policies issued on behalf of the NFIP and policies issued on behalf of private insurance companies and contact an insurance agent as to the availability, cost and comparisons of flood insurance coverage.

Federal law may require a lender or its servicer to escrow all premiums and fees for flood insurance that covers any residential building or mobile home securing a loan that is located in an area with special flood hazards.

If a lender notifies a consumer that an escrow account is required for a loan, then the consumer must pay the flood insurance premiums and fees to the lender or its servicer with the same frequency as he or she makes loan payments for the duration of the loan. These premiums and fees will be deposited in the escrow account, which will be used to pay the flood insurance provider.

Lenders and servicers can effectively meet the requirements of this new flood rule while not drastically increasing their bottom line expenses by making sure there are escrow accounts attached to the loans. This is the best way to comply with the new rule. Otherwise, lenders run the risk of being fined if they are audited and found not in compliance.

Elly Leonida Is vice president/operations manager-flood for LERETA LLC in Covina, California. She can be reached at
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Comment:To escrow, or not to escrow: new flood insurance rules.(COLUMNS: SERVICING)
Author:Leonida, Elly
Publication:Mortgage Banking
Date:Apr 1, 2016
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