VIDEO: Flood Insurance for Buildings With Limited Utility or Value
In this Compliance Clip (video), Adam explores the topic of flood insurance as it relates to buildings with limited utility or value, focusing on a case involving a construction-to-permanent loan. Using insights from interagency guidelines, Adam clarifies the insurance requirements for properties in flood-prone areas, even when the structures may not hold significant value.
Video Transcript
The following is a transcript of this video.
This Compliance Clip is going to talk about flood insurance for buildings with limited utility or limited value. So this is a flood insurance topic.
The question I received was this: we have a construction-to-permanent loan, it's a single-closed loan, where the existing residential dwelling will be demolished and is not used as collateral for the loan. Would flood insurance be required on the dwelling until it is demolished? The new residential dwelling will not use the existing foundation. The foundation will also be demolished and a new one poured.
What this question is saying is we have a construction-to-permanent loan where the existing residential dwelling will be demolished, and they say is not used as collateral for the loan. Now, my question is, is it truly collateral? Because the trick with flood insurance is maybe you're not worried about the value of the structure from an underwriting perspective, but if that structure is on the property you're securing, then that structure is, in fact, collateral. So while you say that this is not collateral, my first question is, is this really collateral for the loan? Because if you're taking the property that the building sits on, it is collateral for the loan, and that makes a difference.
Now, if it's not collateral for the loan, and you're taking a property over here, ag land maybe for example, over here, and the residence is over here, and it's truly carved out, and the land that the house sits on is not, in fact, collateral, then this would not require flood insurance. I'm getting a little bit ahead of myself, but the way this question is worded, I think it's important to distinguish that.
Now, let's assume the property, or underneath the house is collateral, so the house, in fact, is collateral, but you're not worrying about the value. And that's usually the case, we're not worried about the value because we know they're tearing it down, and so that's a non-issue. We're not looking at the value for this loan. So in that case, let's take a look at the Interagency Flood Frequently Asked Questions. They will tell us whether or not we need flood insurance for a structure that is taken as collateral but has no value.
So again, the key here is to understand if it truly is collateral. And just because you don't view it as value, it may be collateral. So is it collateral? And if it is, then we can go to the Flood Frequently Asked Questions. Now, in the Interagency Flood Frequently Asked Question under the Applicability section question number two, specifically says this: some borrowers have buildings with limited utility or value, and in many cases, the borrower would not replace them if lost in a flood. The question here is, must the lender require flood insurance for such buildings?
So I've seen this question for old barns, I've seen it for silos. I've driven in my area, there's a number of barns that are just crumbling. I see roasts caving in, I saw one completely shift off its foundation. My buddy had a silo where the top was falling down, and all he's got now are the pillars going up, so he doesn't have a roof on it. So it's probably not considered a structure under flood regulations. But this happens a lot in ag land. But a lot of times, these structures are put in flood zones. They come back being in a flood zone, and that means we have to have flood insurance if we've got a loan on that collateral. And so, this is the question here.
So let's take a look at the answer provided in this Interagency Flood Frequently Asked Question. The answer is, lenders must require flood insurance on a building or mobile home when those structures are part of the property securing a loan and are located in a high-risk flood zone in a participating flood community. So if it's truly taken as collateral, it does have to have flood insurance, even if you don't view it as having any value. That's what the flood insurance rules require. However, the FAQ goes on to tell us that flood insurance is not required on a structure that is part of a residential property but is detached from the primary residential structure of such property and does not serve as a residence, and is for consumer purposes. So, this would be the example of a silo or barn that's part of a residential property and does not serve as a residence.
Now, a residence is maybe not a house that we're going to tear down. That is a residence because it has a kitchen, it has a bathroom, it has bedrooms. And so, what we're talking about that it does not serve as a residence are structures like a barn or a silo that do not have a bathroom, kitchen, or bedroom. And so, that's how the detached structure works. In short. The answer goes on to tell us that if the limited utility or value structure does not qualify for the detached structure exemption, which is the case in having a residence that we're going to tear down that doesn't qualify for this detached structure exemption because it is a residence, then a lender may consider carving out the building from security it takes on the loan to avoid having to require flood insurance on the structure. And that may be the case of this original question, and that's why I wanted to clarify this at the top.
Now, the Flood Frequently Asked Question does say this, however, it says the lender should fully analyze the risks of carving out. A structure because it could make it difficult to sell the property if you ever had to foreclose on that property. So that is the guidance on flood insurance for buildings with limited utility or value. And I think it makes it clear it's not the answer that many of us want when we have a residence that's going to be torn down or a silo we wouldn't replace or barn we wouldn't replace if it fell down, but it's in a high-risk flood zone. Unfortunately, we still have to get flood insurance on that structure. That's how the rules are. Unless, of course, it qualifies for the detached structure exemption, which a residence would not, by nature of the fac, it is a residence and cannot qualify for the detached structure exemption.
Hopefully, this answers that question. There's a lot here to unpack, but I think that this does answer the question for today.