Flood Insurance and Construction Loans

Issue/Question

The Bank wants to close a loan on a property located in a flood zone with a building under construction. The building has no roof or floor and the walls are not completed. Is flood insurance required at this time, or is the requirement triggered when the borrower has completed the grading and the construction of the walls and roof of the structure?

Response Summary

A loan secured by a building to be constructed in a special flood hazard area is a designated loan for flood purposes, for which the mandatory flood insurance purchase requirements must be fulfilled. A lender can meet these requirements either by having flood insurance in place at closing or deferring the purchase of flood insurance until the start of construction. Flood insurance must be in place when the foundation slab is poured or the Base Flood Certificate is obtained, unless the building to be constructed will have its lowest floor below the Base Flood Elevation, in which case it can be deferred until the walls and roof are up.

Response Detail

Under the Flood Disaster Protection Act, as implemented by the Flood Regulation, a lender may not make, increase, extend, or renew any “designated loan” secured by a building or a mobile home, located or to be located in a special flood hazard area (“SFHA”) for which flood insurance is available, unless the property is covered by adequate flood insurance for the term of the loan. [12 CFR §339.3].

If the building to be constructed is located or will be located in an SFHA for which flood insurance is available, the loan is a designated loan and the lender must provide the required notice to the borrower prior to loan origination that flood insurance is required. The lender must then comply with the mandatory purchase requirement under the Act and Regulation. [Loans in Areas Having Special Flood Hazards: Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q.20].

Buildings in the course of construction that have yet to be walled and roofed are eligible for coverage except when construction has been halted for more than 90 days and/or if the lowest floor used for rating purposes is below the Base Flood Elevation (“BFE”). Materials or supplies intended for use in such construction, alteration, or repair are not insurable unless they are contained within an enclosed building on the premises or adjacent to the premises. [FEMA, Flood Insurance Manual, GR 4].

While an NFIP policy may be purchased prior to the start of construction, coverage under an NFIP policy is not effective until actual construction commences or when materials or supplies intended for use in such construction, alteration, or repair are contained in an enclosed building on the premises or adjacent to the premises. [Interagency Q&A, Q.21].

“Start of construction” is defined as “either the first placement of permanent construction of a building on site, such as the pouring of a slab or footing, the installation of piles, the construction of columns, or any work beyond the stage of excavation; or the placement of a manufactured (mobile) home on a foundation.” [FEMA, Flood Insurance Manual, DEF 9].

In complying with the mandatory purchase requirement for a loan secured by a building in the course of construction, a lender has two alternatives:

• Require the borrower to have flood insurance in place at the time of loan origination, which will become effective at the start of construction or when the construction materials are on-site
• Defer the purchase of flood insurance until either a foundation slab has been poured and/or an elevation certificate has been issued; or, if the building to be constructed will have its lowest floor below the BFE, when the building is walled and roofed.

If the lender elects the last approach and does not require flood insurance to be obtained at loan origination, then it must have adequate internal controls in place at origination to ensure that the borrower obtains flood insurance no later than when the foundation slab has been poured and/or an elevation certificate has been issued. Deferring the purchase of flood insurance until the walls are up and the building roofed is permissible only when the building, as constructed, will have its lowest floor below the BFE.

The lender must require the borrower to have flood insurance in place before the lender disburses funds to pay for building construction (except as necessary to pour the slab or perform preliminary site work, such as laying utilities, clearing brush, or the purchase and/or delivery of building materials) on the property securing the loan. [Interagency Q&A, Q.22].

This entry was posted on Friday, November 14th, 2014 at 7:46 pm.