Will the Private Flood Insurance Bill Bring a Flood of Bad Mortgages?

by Robert Smith

Originally Published - Jul 05,2016

As the old adage goes, "All that glitters is not gold." Or in this case, "All that says 'Flood Insurance Policy' does not insure," at least not for the lender. I recently received a humbling reminder of why it is important to read a bill yourself, no matter how many reputable professional organizations get behind it.

Recently, the House of Representatives passed a bill that would enable private insurers to get more involved with flood and supplement the NFIP. If you look around for comments by those in the lending industry, you will find overwhelming support for this idea. It is a good concept, but that does not mean it is immune to flaws being implemented.

National Mortgage News released an article quoting Anne Canfield, Executive Director of the Consumer Mortgage Coalition, about what could easily turn into a massive flaw. To summarize her comments, there are two problems in the bill that could seriously undermine the ability of lenders to safely issue mortgages on properties in high-risk flood zones.

First, government sponsored enterprises and their servicers would not be permitted to reject private policies which insurance regulators approved if they are believed to have inadequate protection. Worried about that huge deductible with this borrower's income? Think an exclusion could come into effect too easily? Too bad. If it's a Fannie or Freddie loan, you're taking that policy.

Second, the bill as-is would enable the insurers to pay the borrower directly. The lender or servicer does not have to be named as a loss payee on the policy, and again, the policy would have to be accepted. That means a borrower could make a minimum down payment, get a high deductible flood insurance policy, and if a flood hits they could just walk away with the cash in hand.

There is a version of this bill currently in the Senate, and the Senate Banking Committee may well catch this problem and push to fix it from their side. Even so, it is a little surprising to look back at the overwhelming support for this bill, both in the House and from professional organizations, and realize either no one raised this problem or no one took it seriously. What might happen in years like 2005 and 2012? Would it really help consumers in the long run if lenders become unwilling to take on the risk of a property in a SFHA?

None of this is to prop up myself. I got as caught up in the good feeling that we might be moving toward a solution as anyone. Regardless, it should serve as a reminder to us all that any given solution is not necessarily a good one. We should also, like Ms. Canfield, be ready to approach the issues facing the industry with healthy skepticism.