Month: October 2015

Flood Insurance and Keeping Pace with a Construction Loan

Issue/Inquiry

The Bank recently closed a construction loan for $2.9 million, for which it advanced $200,000 at closing. The customer is now requesting an additional $648,000. The property consists of two lots, both of which are in a flood zone “AO”. The foundation has been built and the customer has indicated that the insurance agent stated that the customer can only get $25,000 in flood insurance at this time. Additionally, the customer raised the building 3.5 feet and will be applying for an elevation certificate. How much insurance should the Bank be requiring of the customer at this time?

Response Summary

For construction loans, flood insurance does not have to be in the full amount of the finished project, but can be purchased to keep pace with new construction. What the Bank must determine at each stage of construction will be the replacement cost of the structure already completed. The cost of materials will not be included, since these are not insurable against flood hazard. If insurance is obtained sufficient to cover the value of the structure at each phase of construction, it will satisfy the flood insurance requirements.

Response Detail

Whether the Bank must require the borrower to have flood insurance for a construction loan before making disbursements and the amount of the coverage that must be in place when such coverage is required will depend on the stage of construction.

Under the Flood Rules, a lender may allow a borrower to 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 Base Flood Elevation, when the building is walled and roofed.

The lender, however, 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). It must also 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. Interagency Questions and Answers Regarding Flood Insurance, Q. 22.

In this case, if the initial disbursement of $200,000 was for preliminary work prior to pouring the foundation slab, the purchase of materials, or for the pouring of the slab, then it was properly made even though the borrower had not yet provided proof of flood insurance coverage.

Now that the foundation is in place, however, it will be necessary for the borrower to provide proof of flood insurance coverage before the Bank can make further disbursements.

The general rule is that the amount of flood insurance required is the lesser of:

• The outstanding principal balance of the loan
• The maximum amount of insurance available under the NFIP, which is the lesser of:
  • The maximum amount available for the type of structures
  • The “insurable value” of the structures. Loans in Areas Having Special Flood Hazards: Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q.14; FDIC Compliance Manual, V-6.4

With respect to construction loans, flood insurance does not have to be in the full amount of the finished project, since an NFIP policy will pay no more than the insurable value, but can be purchased to keep pace with new construction. FDIC Compliance Examination Manual, V – 6.2; Interagency Q&A, Q. 14. This means that the amount of flood insurance coverage will be incrementally increased from time to time to cover the increasing value of the structure as it is constructed.

In determining this value, the Interagency Q&A once noted in Question 9:

In calculating the amount of insurance to require, the lender and borrower (either by themselves or in consultation with the flood insurance provider or other appropriate professional) may choose from a variety of approaches or methods to establish the insurable value. They may use an appraisal based on a cost-value (not market-value) approach, a construction-cost calculation, the insurable value used in a hazard insurance policy (recognizing that the insurable value for flood insurance purposes may differ from the coverage provided by the hazard insurance and that adjustments may be necessary; for example, most hazard policies do not cover foundations), or any other reasonable approach, so long as it can be supported.

While this answer has been removed from the current Interagency Q&A, it remains valuable guidance. In making the determination, however, two particular factors should be kept in mind:

• The materials or supplies used in construction or repair are not insurable against flood hazard unless they are in an enclosed building located on or adjacent to the premises. Federal Reserve Bank of Philadelphia, Consumer Compliance Outlook, Fourth Quarter, 2011. These materials should be covered under a Builder’s Risk insurance policy, but unless they are in an enclosed building, their value would not be considered for flood insurance purposes at any particular phase of construction.

• The amount of available flood insurance would not be affected by whether a survey and/or elevation certificate has been obtained, as the NFIP allows a policy to be issued based on estimated elevation from the builder’s plans. Upon renewal, the policy will be issued based on actual elevation and value. FEMA, NFIP Flood Insurance Manual (GR 4, APP 6, and PRP 16).

What the Bank will determine at each stage of construction will be the replacement cost of the structure already completed. It should document the basis for its determination of this value. If insurance is obtained sufficient to cover this amount, it will satisfy flood insurance requirements, even if the better part of any disbursement is for the purchase of materials, which cannot be covered by flood insurance. The amount of insurance will be increased as the value of the structure increases.

Closing Attorney Fees under TRID and as a Finance Charge

Issue/Inquiry

The Bank made a loan in Georgia. The Contract of Sale states that the Borrower can select the closing attorney and the closing attorney will close for the Bank. The Bank disclosed the fee in section C of the Loan Estimate with a 10 percent tolerance and included it in the “Additional Details for Services You Can Shop For”. Is this correct and is the fee considered a prepaid item finance charge?

Response Summary

Ordinarily, the services of a closing attorney would not be services for which a consumer would be allowed to shop.  In this case, however, state law gave that right to the borrower, meaning that they were services the borrower could shop for. If the Bank listed the service and estimated fee in “Services You Can Shop For” and the name and contact information of at least one attorney in “Additional Details for Services You Can Shop For,” it will have satisfied the TRID requirements.

If the Bank required a closing attorney, then the fee would probably be included in the finance charge, even if the borrower chose the closing attorney.

Response Detail

On the face of it, the Bank properly disclosed the service and fee of the closing attorney, assuming that the disclosure fulfilled the requirements of the TILA RESPA Integrated Disclosure (“TRID”) Rules.

Generally, the Loan Costs disclosed on the Loan Estimate are those costs paid by the consumer to the creditor and third-party providers of services the creditor requires to be obtained by the consumer during the origination of the loan. 12 CFR §1026.37(f).

Loan Costs are broken down into three categories:

• Origination Charges
• Services You Cannot Shop For
• Services You Can Shop For

“Services You Can Shop For” are provided by persons other than the creditor or mortgage broker and are services that the consumer can shop for and will pay at settlement. 12 CFR §1026.37(f)(3).

In this case, the Bank would have required a closing attorney, which is usually a service the consumer would not have been allowed to shop for. Under Georgia law, however, the borrower has the right to choose the closing attorney. Since the borrower would have been allowed to shop for the attorney providing this service, it would have been properly listed on the Loan Estimate in Loan Costs under “C. Services You Can Shop For.”

The Bank would have used clear terminology in describing the service – “closing attorney” would have been sufficient – and if there was more than one service listed in “Services You Can Shop For,” they would have been arranged in alphabetical order. 12 CFR §1026.37(f)(5).

When the consumer is allowed to shop for a service, the Bank must provide a list to the consumer (“Additional Details For Services You Can Shop For”) with at least one provider of the service listed on it. The list would have identified the service, the estimated fee, and the name and contact information for the provider. § 1026.19(e)(1)(vi); Official Interpretations, ¶37(f)(3)-1.

If the Bank listed the service and fee in “Services You Can Shop For” and the name of at least one provider in “Additional Details for Services You Can Shop For,” then it fulfilled the TRID requirements.

As to whether the fees of the closing attorney are to be included in the finance charge, Regulation Z provides as follows:

Fees charged by a third party that conducts a loan closing (such as a settlement agent, attorney, or escrow or title company) are finance charges only if the creditor:

1. Requires the particular services for which the consumer is charged
2. Requires the imposition of the charge
   
3. Retains a portion of the third-party charge, to the extent of the portion retained. 12 CFR §1026.4(a)(2)

If the Bank required the services of a closing attorney, then the fees of the attorney would be included in the finance charge even if the borrower selected the closing attorney.

Regulation Z provides an exception to this requirement. If a lump sum is charged by the attorney for conducting or attending a closing, it would be excluded from the finance charge if the charge is primarily for services related to such services as preparing or reviewing documentation or the title, which would be excluded in under section 1026.4(c)(7) of the regulation. Official Interpretations, ¶¶4(a)(2)-2, (c)(7)-2.

Refund from Escrow Account

Issue/Inquiry

For a loan that closed in June 2015, the Bank sent out the “Tax and Insurance Account Disclosure Statement” for the escrow being taken. The Bank just discovered that it had been requiring the customer to pay $60 a month for more than was necessary.  At the present time, there is a surplus of $400 in the account.

The Bank believes that it is supposed to send the computation on, at least, an annual basis. What would be the proper way to remedy this situation?  Can it send another computation?  And if it does send another one, when does the new computation year begin?

Response Summary

RESPA allows the Bank to perform a “short-year” analysis to make adjustments in target balances and the payments needed to reach them and to identify any surplus. The short-year analysis will also establish a new “escrow account computation year.” If the analysis reveals a surplus greater than $50, the entire surplus must be refunded to the borrower.

Response Detail

Ordinarily, a bank must provide the borrower with an escrow account statement at least once for each 12-month period, known as an “escrow account computation year.” This annual statement will be based on an escrow account analysis to:

• Determine the appropriate target balances
• Compute the borrower’s monthly payments for the next escrow account computation year
• Compute any deposits needed to establish or maintain the account
• Determine whether shortages, surpluses, or deficiencies exist. 12 CFR §§1024.17(d), (f)(1).

There is no requirement to make the adjustment or to notify the borrower of a surplus or deficiency more often, but only to reflect the changes that have occurred in the amounts of the charges and fees being escrowed for.

The annual statement will itemize such factors as:

• The amount of the borrower’s current monthly payment
• The portion of the monthly payment being placed in the escrow account
• The total amount paid out of the  escrow account during the period for taxes, insurance premiums, and other charges, as separately identified
• The balance in the escrow account at the conclusion of the period
• An explanation of how any surplus is being handled
• An explanation of how any shortage or deficiency is to be paid by the borrower
• The reasons why the estimated low monthly balance was not reached, if applicable

This statement would be submitted within 30 days of the completion of the computation year. If the escrow account analysis discloses a surplus, a bank must, within 30 days from the date of the analysis, refund the surplus to the borrower if it is greater than or equal to $50. 12 CFR §§1024.17(i); (f)(2)(i).

If a bank would want to adjust the payments sooner, RESPA allows what are called “short-year” statements to be issued to end the escrow account computation year and establish the beginning date of the new computation year. An escrow account analysis would be performed just as for the annual statement, but it would reflect a trial balance of the account during the short-year rather than the 12-month period for the annual statement. The short-year statement would be provided within 60 days of the end of the short-year. 12 CFR §1024.17(i)(4).

Banks often use short-year statements to bring the escrow account computation year into line with their business cycles. A bank could also use it in the present situation, however, as a way of reflecting changes in payments or to resolve a surplus, rather than waiting for the end of the escrow account computation year.

What the Bank should do in this case is perform an escrow account analysis to determine the appropriate amount of the target balances and the payments to meet them, and identify the amount of the surplus. It will then issue a short-year statement to the borrower, which will establish a new escrow account computational year. If the surplus exceeds $50, it will refund the entire surplus to the borrower, not just the amount that exceeds $50.