While flood insurance compliance is extremely important due to potential fines and penalties, the rules can be quite confusing and cumbersome for both customers and financial institutions. For example, when a structure is found to be in a high-risk flood zone, flood rules require that a flood notice be sent to the applicant advising them of being in a flood zone, their responsibilities for obtaining insurance, and a few other disclosures. These rules, however, don’t provide time-frames on when, exactly, the flood notice must be delivered. Therefore, there has been quite a bit of confusion over the timing requirements of the flood notice that must be delivered to borrowers who have a collateralized structure in a high-risk flood zone.
Background on the 10-Day Requirement for the Flood Notice to Borrower
In the past, flood rules for financial institutions were governed by FEMA who issued guidelines for banks to follow, known as the Mandatory Purchase of Flood Insurance Guidelines. At one point, these guidelines explained that a reasonable period of time was ten day before loan origination. That said, these guidelines eventually removed this reference to the ten-day period and were actually rescinded on October 9, 2014.
While the current flood insurance rules don’t technically have a clear 10-day requirement, they do state that the flood notice must be delivered a “reasonable time” before originating the loan. As you would expect, the phrase “reasonable time” can be debated many different ways (and it has been!). As the Mandatory Purchase of Flood Insurance Guidelines removed the ten-day reference before they were rescinded, many are left wondering if the notice still must be provided at least ten days before closing, or if a period of less than ten days would be considered a “reasonable time.”
Providing the Flood Notice Less Than 10 Days Before Closing
While current flood insurance rules don’t provide a minimum timeframe that satisfies the “reasonable time” requirement for delivering the flood notice, many in the industry feel that a period of less than ten days would be deemed appropriate. For example, if a customer currently has a loan with you where you already require flood insurance, and they go to refinance their loan, it would seem pointless to require this existing customer (who already has a loan with you and already has flood insurance with you) to wait ten days before they can close on their refinance. Therefore, many in the industry believe that a period of less than ten days would be an appropriate and “reasonable time” before closing.
Regulator Expectations for Providing the Flood Notice to Borrower 10 Days Before Closing
As explained in the beginning of this article, the challenge with this rule is that a “reasonable time” is not defined in the actual law or regulation. These two documents (law and regulation) are what compliance professionals typically use to justify something, like when they are required to provide a flood notice.
That said, some of the regulators have provided “guidance” that says they expect their regulated institutions to provide/deliver the notice at least ten days before loan closing/origination. For example, the Kansas City Branch of the Federal Reserve made the following statement in 2018:
"Moreover, the timely delivery of the SFHA notice requires some additional attention. Given that Regulation H does not specifically define what constitutes a reasonable time to provide the SFHA notice prior to loan origination, the rule of thumb to ensure compliance is to complete the flood determination as soon as the bank knows the location of the property securing the loan and to immediately provide the SFHA notice if determined to be located in a special flood hazard area. In most cases, it is prudent to follow the flood Q&A that addresses the timing of the notice by providing the notice at least 10 days prior to loan origination. In instances where the 10-day timeframe is not met, banks must provide sufficient documentation to demonstrate that it provided the SFHA notice as soon as reasonably practicable."
As you can see, this guidance basically says that if you don’t provide the notice ten days before closing/origination, then a Federal Reserve regulated bank “must” have sufficient supporting documentation in the file to justify the shorter period of time.
While this guidance from the Kansas City Fed does appear to acknowledge that a period of less than ten days before closing could be acceptable for delivering the flood notice to the borrower, we have heard reports over the years that field examiners sometimes still take a hard ten day approach to the “reasonable time” requirement, even though neither the law or regulation seem to say this.
Providing the Flood Notice at Closing
Regardless of whether you think the ten-day rule must be followed or that a period of time less than ten days is considered to be an acceptable “reasonable time” before closing, almost all in the industry agree that providing the flood notice to the borrower at the time of loan origination/closing is not a reasonable time before closing and would be considered a violation. In fact, we have heard several stories over the years where examiners have cited banks for not complying with the “reasonable time” period for delivering the flood notice when the notice is only provided (and signed) at closing.
Conclusion for Providing the Flood Notice to Borrower
The bottom line is that each financial institution should determine whether they are going to create a firm policy requirement for delivering/providing the flood notice to the borrower at least ten days before closing, or whether they are going to allow for time periods shorter than ten days (with appropriate supporting documentation in the file to justify the shorter period of time).
The conservative approach, of course, is to require the notice be delivered at least ten days prior to closing of every loan. That approach, however will also result in delayed closings for long-time refinance customers, so the choice should be carefully weighed by each financial institution.
The full article from the Kansas City Federal Reserve can be found here.