VIDEO: No Value Buildings & Flood Insurance
In this Compliance Clip (video), Adam explains what can be done when a structure is located in a high-risk flood zone, but a customer doesn’t want to get flood insurance because the building is old, unusable, or wouldn’t be replaced if it was damaged. This is a great video to share with your lending team who may ask this question from time to time.
Video Transcript
The following is a transcript of this video.
This Compliance Clip is going to talk about no value buildings and how they relate to flood insurance. Sometimes, we have lenders who may be doing a loan, maybe for example, an agricultural loan, or maybe even just a regular mortgage, where there's an old building on the property and the customer is adamant that they're not gonna use that building and if it were to fall down, then they're not going to replace it. It's just an old dilapidated building. Whatever the case may be, it may be a farm, it may be a residential structure, or it may be a residential property, it may be a number of things, but there's an old building that from the lender's perspective has no value. In fact, the appraisal may not have given the building any value at all, but that structure happens to be in a high-risk flood zone, and therefore your compliance officer is telling you that you need to have flood insurance on this structure. The question is, what do we do in these cases where we have these buildings with no value, but they're in a high-risk zone? What do we have to do for flood assurance requirements?
This is actually a question that is answered in the May 2022 Questions and Answers regarding flood insurance from the interagencies. This is official guidance from the regulators and they ask this question that we’ll answer here in just a minute. Question says, must the lender require flood insurance for such buildings with limited utility or value, which in many cases, the borrower would not replace them if it was lost in a flood? And that's the abbreviated version of the question.
The answer goes on to tell us a number of things, and this is also abbreviated. It tells us, first of all, yes, if those structures are part of the property securing the loan and are located in a participating community that participates in the Standard Flood Hazard program, then in fact, you do have to require flood insurance. So the answer is yes. Even though the structure may have no value from an appraisal perspective or even from collateral, you're not concerned about it, if you're taking it as collateral and it's in a high-risk zone in a participating community, you have to obtain flood insurance.
There's a couple of things we can look at because there is something called the detached structure rule. Keep in mind that flood insurance is not required on a structure that is part of a residential property. So a residential property, not a commercial property, not agricultural property, but a residential property, but is detached from the primary residential structure of such property and does not serve as a residence. If you have an old farmhouse and there's an old silo that happens to be in a high risk flood zone, and that silo does not serve as a residence, it is not attached to the residence, but it's part of the residential property and it's not used for commercial purposes, then it could be exempt based on the detached structure exemption. That's one way you might get around this rule to require flood insurance for a building with no value. But if it's used for commercial purposes where you're storing commercial equipment or using it as a shop for money, for business, then the detached structure exemption would not apply.
There's another option. Let's say that this is ag land and all that's on there is a single silo and it needs flood insurance because it is a structure. Well, in that case, one of the options you have is you can carve out the silo out of the collateral. What the answer tells us is this: If the limited utility or value structure does not qualify for the detached structure exemption, a lender may consider “carving out” the building from the security it takes on the loan to avoid having to require flood insurance on the structure. Essentially if it's on the corner of ag land, you can just say that this corner's not part of our collateral. If you repossess it, you don't get the structure, but that may be okay to you if that structure's not worth anything and you're worried more about the ag land. So that is an option you have. The old Q&A used to warn us that you need to be careful of this. It is important to understand that if you have the silo in the middle of the property and there's no there's no driveway to get there and there's no land carved out as well, that could be a problem from your regulator's perspective. But this is something that the Q&A tells us we could consider. If these two things don't apply, however, you would have to require flood insurance.
That is the topic of flood insurance on buildings with no value, and that's all I have for you for this Compliance Clip.