Flood Insurance For Structures With No Value
In this Compliance Clip (video), Adam explains the flood insurance requirements for structures that have no value - such as an old barn that would likely be torn down and not replaced if a flood damaged it.
Video Transcript
The following is a transcript of this video.
This Compliance Clip is going to focus on flood insurance for structures with no value.
A question I've received many times over the years is, “Is flood insurance required when a structure with no appraised value is in a flood zone?” This is a question I get quite a bit, especially when you have an ag lender or a commercial lender who is lending maybe a hundred acres and there is an old, dilapidated barn that's still standing, or an old house that's pretty much condemned and not being used, or a silo. And the question is, since it's in a flood zone, do we need flood insurance? And usually in these cases, especially with these ag loans, the appraisal says there's no value or it doesn't even talk about the structure because all they're worried about is the land.
The answer for this, of course, is going to come from potentially two places. The first place is from the Detached Structure Exemption. Now, this is not actually the focus of our video today, so we're not going to spend hardly any time on this, but if the structure is part of a residential property, and it's not used for commercial or business purposes, and it's not attached to a dwelling, then you could exempt it and not require flood insurance. But that's a whole different conversation. I have a whole different video on that.
The second part of our answer that we're going to talk about today comes from the Flood Frequently Asked Questions, and this relates more to those instances where we have a hundred acres and we have that silo or barn that if it flooded, they would just tear it down. So let's look at the Flood Frequently Asked Question No. 24. Specifically, it says, “Some borrowers have buildings with limited utility or value and, in many cases, the borrower would not replace them if lost in a flood. Is a lender required to mandate flood insurance for such buildings?”
Now, again, this is the case where the appraisal probably says there's no value. The handwriting says there's no value. They're not concerned about the value of the structure, they're concerned about the value of the land. I get it. From a safety and soundness perspective, we don't care about this structure. But unfortunately, flood insurance rules are different. Here's the answer in the frequently asked question. The answer is yes, flood insurance is required. It says, “Under the Regulations, lenders must require flood insurance on real estate improvements when those improvements are part of the property securing the loan and are located in a standard flood hazard area in a participating community.” So the answer is absolutely yes, flood insurance is required.
Now, you may be scratching your head saying that's crazy. Well, it is. The good news is that Flood Frequently Asked Question No. 24 gives us a little bit of an out. It goes on to say that the lender may consider carving out the building from the security it takes on the loan. So if you have a hundred acres and on the very far corner you have this silo that’s standing there and you don't need this, you could actually carve that out from your collateral, and in your legal documents, carve it out then take everything else and therefore you would not need flood insurance on that structure that's no longer in your collateral.
But if you do that, the frequently asked question goes on to give some warnings and said that certain risks need to be considered. You have to make sure that you'll be able to market the property in the event of a foreclosure. So if there's a structure in the middle of the property you're taking as collateral, how in the world are you going to sell that property without having ownership of that structure in the middle? So you have to look at that. You also have to look at any local zoning issues that would affect the collateral as well. But that's an option.
So long story short is that flood insurance is required but there are some options for reducing the amount of flood insurance that has to be purchased, which we didn't get into, or by maybe carving this out.
That's all I have for you today in this short Compliance Clip.