Federal Law and Hazard Insurance Requirements

Issue/Inquiry

The Bank is making a small commercial loan to repair the roof of a hunting club, which will be secured by a mortgage on the property. There is currently no hazard insurance on the property and it would be difficult for the club to obtain such. Is the Bank required by federal law to force place hazard insurance?

Response Summary

Generally, a financial institution is not required by federal laws or regulations to have real estate collateral covered by hazard insurance. The Real Estate Settlement and Procedures Act (“RESPA”) does allow an institution to force place hazard insurance, provided that its rules are followed, but this is only applicable to loans secured by dwellings. The Bank should consider whether safety and soundness concerns justify the requirement of hazard insurance. If the value of the land securing the loan is sufficient to repay the loan, an argument can be made that hazard insurance is not necessary to protect the loan.

Response Detail

A financial institution is not required by federal laws or regulations to require hazard insurance on real estate collateral. Generally, the decision to require such insurance is a matter of contract and safety and soundness concerns.

RESPA, which is implemented by Regulation X, does not require a bank to have hazard insurance in place covering collateral property. However, if such coverage is required by contract, RESPA allows an institution to force place hazard insurance, provided that the notification and payment rules of the regulation are followed.

RESPA covers federal mortgage loans, which are loans for consumer purposes secured by dwellings. In this case, since the purpose of the loan is for a business purpose, the RESPA requirements are not applicable. Whether the Bank wants to require hazard insurance coverage for the hunting lodge securing the loan, and whether such coverage can be force placed, is a matter to be determined by the Bank and the borrower.

The absence of insurance coverage on real estate collateral may be considered a safety and soundness concern, as missing or inadequate property insurance is regarded by the FDIC as an indicator of a potential problem. If the value of the collateral is adversely affected by hazards and the damage is not covered by insurance, there is a greater risk to the financial institution that the loan will not be repaid.

The Bank should determine what the loan-to-value of the land is. If the determination demonstrates that a collateral interest in the land is sufficient to secure the loan, then an argument can be made that hazard insurance is not necessary to protect the loan. In this case, the Bank would document the reasons for this conclusion and keep such documentation on file.

This response is for informational purposes only and is not intended for legal guidance.

This entry was posted on Monday, August 17th, 2020 at 9:35 am.