"Just a few inches of water from a flood can cause tens of thousands of dollars in damage," according to the National Flood Insurance Program. This fact sums up why mortgage lenders sometimes require borrowers to get flood insurance. When property values decline significantly, homeowners facing possible foreclosure are often eager to avoid these additional expenses and leave the problem with the lender.
However, real estate agents and mortgage lenders often don't tell customers about flood insurance requirements until a property is already in escrow. Homeowners are also unaware that many areas that do not immediately appear to be at high risk of flooding are actually rated as high risk by the Federal Emergency Management Agency (FEMA). If you've found yourself in this situation or you don't want to be caught off guard, this article will help you by demystifying lender-required flood insurance.
Why Do Lenders Require Flood Insurance?
Homeowners insurance policies (also called hazard insurance) do not cover flooding - only a separate insurance product can protect against flood damage. Flood insurance is usually optional for mortgaged homeowners in what are normally considered low-risk flood areas. It may even be optional for mortgaged homeowners in high-risk flood areas, depending on the mortgage product. However, homeowners who take out a mortgage from a lender that is federally regulated or insured (such as an FHA mortgage) and buy a home in a high-risk flood zone (also known as a Special Flood Hazard Area) will be required to buy flood insurance. In most cases, the homeowner will have to pay for flood insurance every year until the mortgage is paid off.
When someone takes out a mortgage, the home serves as collateral if the borrower stops making mortgage payments. When a property is financed, the lender often has a greater financial stake in the property than the borrower. If one of the lender's assets is damaged by flood waters and the borrower abandons the home and stops making mortgage payments, the lender is caught in a losing position. To eliminate this risk, many lenders require the homeowner to purchase flood insurance.
The homeowner is not likely to walk away from a damaged home when it can be repaired at minimal cost. Flood insurance will provide money to repair or even rebuild a home if it is damaged or destroyed by flooding. The homeowner will keep the home and keep making mortgage payments. If the homeowner has to file a claim, he or she will only be responsible for paying the deductible. If the homeowner cannot pay the deductible, which may be as high as $5,000, there is still some risk that the homeowner could walk away. Also, since flood insurance maxes out at $250,000, as we'll discuss later, the owner might also be tempted to walk away from a property that will cost significantly more to repair or rebuild.
Read More: Source