The U.S. Department of Housing Urban Development (HUD) recently issued a final rule permitting the use of private flood insurance policies with FHA-insured mortgage loans.  HUD also issued Mortgagee Letter 2022-18 addressing with regard to FHA-insured loans general flood insurance requirements, flood insurance requirements for condominiums, manufactured homes and home equity conversion mortgage (HECM) loans (i.e., reverse mortgage loans), and private flood insurance requirements.  Both the final rule and Mortgagee Letter are effective December 21, 2022. 

As previously reported in February 2019 federal regulators issued a joint final rule (the “Joint Final Rule”) to implement provisions of the Biggert-Waters Flood Insurance Reform Act of 2012 (the “Act”) that require regulated financial institutions to accept private flood insurance policies. The regulators are the Farm Credit Administration, Federal Deposit Insurance Corporation, Federal Reserve Board, National Credit Union Administration, and Comptroller of the Currency. Although the Joint Final Rule took effect on July 1, 2019, it does not apply to FHA-insured loans. HUD notes in the preamble to the final rule that the Act does not impose requirements on FHA-insured loans.  Prior to the HUD final rule, HUD only accepted flood insurance policies issued under the National Flood Insurance Program (NFIP). Addressing the rationale for allowing private flood insurance policies with FHA-insured loans, HUD states in the preamble to the final rule that an FHA lender’s “acceptance of private flood insurance policies would provide borrowers with more flood insurance choices, promote consistency with industry standards, reduce the regulatory restrictions on flood insurance for FHA-insured loans, and harmonize FHA policies with the congressional intent expressed in the. . . Act to encourage an expanded private flood insurance market.”

The final rule applies to Title I manufactured home loans, Title II single-family home loans, and HECM loans. Consistent with the Joint Final Rule, to qualify as private flood insurance under the HUD final rule a policy must be issued by an insurance company that meets certain conditions, and the policy must provide flood insurance coverage that is at least as broad as the coverage provided under a standard flood insurance policy (SFIP) issued under the NFIP for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer. The final rule sets forth specific requirements that a policy must meet to be considered to provide coverage at least as broad as a SFIP.

The Joint Final Rule requires an institution subject to the rule to accept a qualifying private flood insurance policy.  In proposing the rule for FHA-insured loans, HUD expressly sought comment on whether the final rule should permit, or should require, a lender to accept a qualifying private flood insurance policy with an FHA-insured loan. HUD decided to adopt a permissive approach. Thus, lenders may, but are not required to, accept a qualifying private flood insurance policy with an FHA-insured loan.    

The final rule permits a lender to determine that a private flood insurance policy is a qualifying policy, without further review of the policy, if the following statement, referred to as a “compliance aid statement,” is included within the policy or as an endorsement to the policy: “This policy meets the definition of private flood insurance contained in 24 CFR 203.16a(e) for FHA-insured mortgages.” In the preamble to the final rule, HUD explains that a lender may elect not to rely on the statement and make its own determination if the policy is a qualifying policy.  HUD also advises in the preamble and Mortgagee Letter 2022-18 that a lender may not reject a policy solely because it is not accompanied by the statement.

Unlike the Joint Final Rule, the HUD final rule does not permit lenders to exercise discretion to accept private flood insurance policies that do not meet the definition and requirements for a private flood insurance policy, or to accept flood coverage issued by mutual aid societies, in connection with FHA-insured loans.

In Mortgagee Letter 2022-18, HUD advises that to be eligible for an FHA-insured loan, a property that is located in a special flood hazard area (SFHA) “must be in a community that participates in the [NFIP] and has NFIP available.” Thus, even if a lender is willing to accept a qualifying private flood insurance policy with an FHA-insured loan, the security property must be located in such a community. 

With regard to the servicing of FHA-insured Title II loans and HECM loans, the Mortgagee Letter provides that a servicer must (1) for properties in a SFHA with flood insurance, annually review if the flood insurance is sufficient, and (2) annually review all properties to determine if a property is located in a SFHA.