In July of last year, the Agencies (FRB, FDIC, NCUA, OCC and FCA) published significant changes to some of the flood insurance rules which became effective on January 1, 2016. One of the significant changes was to the escrow requirements for flood insurance premiums. There appears to be significant misunderstanding of the impact of the new rules, particularly on covered loans that were on a lender’s books prior to January 1.
Prior to the new rules, a lender was required to escrow for the flood insurance premiums for a loan where flood insurance was required if the lender also maintained an escrow for some other item such as taxes or insurance. If the lender did not require an escrow for other items, it was not required to maintain an escrow for flood insurance premiums even though it required flood insurance coverage on the loan. Under the new rules, when the flood insurance regulations require that a lender have flood insurance coverage, the lender must escrow for the flood insurance premium unless it meets one of the exceptions to the new escrow requirements.
For loans that were on the books prior to January 1, 2016, the old rules requiring an escrow apply until there is a triggering event. The triggering events are the same as for the determination of the requirement for flood insurance, that is the making, increasing, extension or renewal of the loan. Accordingly, if a lender had a loan on the books prior to January 1, 2016 where flood insurance was required, but there was no escrow for flood insurance because the lender did not require an escrow for taxes or insurance, the lender was not required to immediately institute an escrow for flood insurance. But if, after January 1, 2016, the lender increased, extended or renewed the loan, an escrow for flood insurance would be required at that point unless the lender or the loan meets an exception. Lenders should be aware that if a triggering event occurs in a loan that was on the books prior to January 1, 2016, the flood insurance escrow become effective as to that loan.
What the new rules do require for loans on the books prior to January 1, 2016, is that a lender offer a borrower the option to escrow for flood insurance if the borrower would like to even though the lender does not require it. The rules also require that the lender provide the borrower a notice of the option to escrow flood insurance premiums. That notice must be provided by June 30, 2016 for covered loans existing before January 1, 2016 for which flood insurance was required but no escrow was established for the premiums. The form for the notice is in Appendix B to the new regulation.
There are two ways to be exempt from the mandatory flood escrow and option to escrow notice rules, either the lender meets the small lender exception or the loan itself meets an exception.
A lender qualifies for the small lender exception if it:
- Had assets of less than $ 1 billion as of December 31 of either of the two prior calendar years; and
- On July 6, 2012,
- Was not required to escrow for taxes, insurance, fees or any other charges in escrow for the entire term of the loan; and
- Did not have a policy of consistently and uniformly requiring the deposit of taxes, insurance premiums, fees or any other charges for the entire term of a loan secured by improved residential real estate or a mobile home.
If a lender qualifies for this exception, the requirement for mandatory escrow and the notice of option to escrow for outstanding loans does not apply to it. However, if a lender should later lose this exception (because its assets exceeded the asset limit for the preceding 2 years), it would be required to escrow for flood insurance for all covered loans made, increased, renewed or extended on or after July 1 of the first calendar year of its changed status. Also, by September 30 of the first calendar year in which the exception was lost, the institution would have to send the notice of the option to escrow to all borrowers who were required to have flood insurance but no escrow was then required.
A loan, itself, may qualify for an exception to the mandatory escrow rules. Exceptions include:
- An extension of credit primarily for business, commercial, or agricultural purposes;
- A subordinate position to senior lien secured by the same residential improved real estate or mobile home for which a borrower has obtained flood insurance coverage meeting the flood insurance requirements;
- A home equity line of credit (HELOC);
- A loan has a term of no longer than 12 months;
- The loan is nonperforming (90 or more days past due) and remains nonperforming until permanently modified or until entire amount past due, including principal, accrued interest, and penalty interest incurred is collected or otherwise discharged in full; and
- The loan for residential improved real estate or mobile home already has a flood insurance policy provided for by condominium, cooperative, homeowner’s association, or other applicable group and premium paid by the association or other applicable group as a common expense.
If a loan falls within this exception, it is not subject to either the mandatory escrow or the option to escrow notice rules. For example, a loan secured by a multi-unit apartment complex, while secured by improved residential real estate is exempt from the mandatory flood escrow rules. Like the small lender exception, a loan may lose its exception status, e.g., a non-performing loan becomes performing. In that case, if at any time during the term of the loan, a lender determines that the loan exception no longer applies, then, escrow of flood insurance premiums and fees with respect to that loan is mandatory as soon as reasonably practical.
Lenders who are required to send the notice of the option to escrow and who have not done so need to do so immediately. If you are intending to sell a covered loan on or before June 30th, 2016, be sure that you have a back-up plan in place to mail or deliver the notice in the event the sale does not go through.