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FHA backed $4.5B in mortgages without required flood insurance

At least 31,500 loans insured by the FHA did not have required National Flood Insurance (NFIP) coverage

The Federal Housing Administration insured thousands of mortgages in 2020 without the mandatory flood insurance coverage.

The potential loss on these loans could amount to $1.5 billion, an audit released this week by the Department of Housing and Urban Development Office of Inspector General found.

According to the watchdog, at least 31,500 FHA-insured loans insured did not have the required National Flood Insurance Program coverage. Those loans, totaling close to $4.5 billion, either had private flood insurance, NFIP coverage that did not meet the minimum required amount or no coverage at all during 2020.

A spokesperson for the Department of Housing and Urban Development said in a statement that effective March 9, all lenders must enter information into HUD’s updated systems to demonstrate that they are complying with federal flood insurance requirements.

“FHA implemented changes to its single-family systems to require lenders to indicate properties in Special Flood Hazard Areas and if so, to provide the applicable flood insurance data electronically,” the HUD spokesperson said.

Properties located in special flood hazard areas must have national flood insurance program coverage. FHA does not permit borrowers to opt for private flood insurance.

The watchdog report said that out of nearly 8.3 million loans with FHA insurance in 2020, approximately 197,747 loans are in areas that require flood insurance.

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The IG said that the administration did not have adequate controls in place to detect when loans did not have the required flood insurance.

One of the problems the watchdog highlighted is that FHA did not require servicers to enter information into HUD’s systems to show compliance with federal flood insurance requirements.

As a result, the administration did not have information on the coverage amount or whether an NFIP flood insurance policy was in place. The IG added that FHA’s handbooks also failed to clearly communicate to servicers about the flood insurance requirements.

The IG recommended the FHA require lenders to provide evidence of sufficient flood insurance and to better detect loans that did not maintain the required flood insurance.

In doing so, “$1.5 billion [will be put] to better use by avoiding potential future costs to the FHA insurance fund from inadequately insured properties,” the report said.

The IG also asked FHA to make any needed adjustments to the forward and reverse mortgage handbooks to ensure consistency with the law.

By implementing these recommendations, HUD will be able to identify properties in its servicing portfolio that do not meet requirements and avoid risk from at least $4.5 billion in ineligible loans each year, the report said.

The report marks the second time in recent years the IG has found that FHA failed to ensure loans in its portfolio were properly covered. An IG report in 2021 found that at least 3,870 loans were insured in 2019 without proper flood insurance, totaling $940 million.

Although the NFIP services a significant chunk of homeowners, the program has had funding problems over the years, in part because Congress requires NFIP to charge discounted premium rates to policyholders.

A report published by the Government Accountability Office in July 2021, found that as of August 2020, the Federal Emergency Management Agency, which manages the flood insurance program, had debt totaling $20.5 billion, even after Congress canceled $16 billion of its debt in October 2017.

The rules surrounding flood insurance may soon change, to allow borrowers to opt for private flood insurance. A rule dubbed “Acceptance of Private Flood Insurance for FHA-Insured Mortgages ” is currently pending on the Office of Management and Budget‘s website.

When implemented, it will undo regulations that have been in place since 1968, mandating that FHA borrowers with properties located in flood hazard areas must purchase government flood insurance.

The FHA has said that allowing borrowers to choose private flood insurance could save them money.

“Acceptance of private flood insurance policies would additionally benefit borrowers who want FHA-insured mortgages, by providing them consumer choice, including the opportunity to obtain private flood insurance policies that may be more affordable than NFIP policies,” the FHA said in the rationale for its proposed rule.

Editor’s note: This story has been updated with a comment from HUD.

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