Flood Insurance Requirements for Lenders You Need to Know

It may be common knowledge among homeowners that flood insurance isn’t required by law. But, even though laws may not require you to purchase flood insurance, your mortgage lender can put stipulations in your contract agreement that state you must maintain adequate flood insurance on your home during the entirety of your loan.

That’s because your lender still has a stake in your investment while you’re paying off your loan. Once your loan has been paid in full, you aren’t under any contractual obligation to keep your flood insurance policy — but we always recommend having it to keep your investment afloat.

Let’s dive into everything you need to know about flood insurance lender requirements, including how much you must have and how to get it.

Mortgage lenders typically require borrowers to have flood insurance if they live in a moderate- to high-risk flood zone, as designated by the Federal Emergency Management Agency (FEMA) and while they still carry a balance on their loan.

However, mortgage lenders can require homeowners living in low-risk flood zones to purchase and maintain flood insurance while there’s a balance on the mortgage. Whether flood insurance is required by your lender or not, it’s always a good idea to maintain adequate flood insurance at all times.

Flood insurance requirements for lenders differ on a case-by-case basis. Some lenders may only make you insure your home for the opposite equity amount you have invested in the property, while others will make you maintain the exact amount of coverage as the home’s value.

So if your home is worth $250,000 and you’ve put a $25,000 down payment on the property, some lenders will require you to insure the full value of $250,000 and others will require you to insure the opposite equity of $225,000.

The major factors for determining how much flood insurance is required by your lender are the value of the home and the amount left on the loan. However, we always recommend getting enough flood insurance to protect the entire value of your home — also known as its dwelling coverage.

Since your mortgage lender has no stake in the belongings you keep inside your house, there are typically no stipulations as to how much personal property coverage you must have. Although, since it covers your belongings like furniture and clothes, we recommend getting enough personal property coverage in your flood policy to replace everything you own.

In the first scenario, let’s say you’re a homeowner with a $250,000 home. If you have $100,000 equity in your home and still owe $150,000 on the mortgage, your lender may only require you to purchase $150,000 worth of flood insurance to protect the structure of the home.

In the second scenario, the lender knows how risky floods can be — and they can strike at any time without warning — so they’ll require you to maintain $250,000 worth of flood coverage at all times, even if you only owe $20,000 on the home. They’re doing this to protect themselves and also protect you in the process.

The amount of flood insurance you can get is determined by which flood zone the house is in and whether you opt to get covered by a private insurer or the National Flood Insurance Program.

Private insurers typically don’t issue policies to homeowners in high-risk flood zones. But they do offer as much coverage as your home is worth. The National Flood Insurance Program (NFIP), on the other hand, specializes in insuring risky homes in high-risk zones. But they max out coverage for individual residences at $250,000 per claim.

So if your home is worth $300,000 and you can’t purchase coverage through a private flood insurer, you’ll have to settle for a $250,000 policy from the NFIP. In that case, you’d be financially responsible to pay the remaining $50,000 if your home was destroyed by a flood. This also creates some difficulties with your lender, as you may not be able to get financing or may have to pay a higher interest rate to offset the risk.

Whichever requirement your lender may have, it’s always smarter to opt for the same amount of flood coverage as your home is worth. Insuring your home to its full value ensures there’s absolutely no margin for error, which is especially crucial when you factor in the minimal cost of flood insurance and the maximum cost of repairs if your home is damaged by a flood.

Lenders require homeowners to get flood insurance to protect their investment and so the home is properly protected against flooding, which is one of the most common and costly natural disasters on the planet.

If a home is damaged by flooding and the homeowner doesn’t have flood insurance to pay for the repairs, they’ll be stuck paying out of pocket for all the repairs needed. And floods can be expensive. In fact, just 1 inch of floodwaters inside a home can cause up to $25,000 worth of damage.

But what happens if the homeowner doesn’t have enough money to pay for the repairs? Then the homeowner can’t make the necessary repairs to fix the home, potentially causing it to go into foreclosure and get repossessed by the very lenders the money was borrowed from.

The major issue with that, besides that homeowners may have no choice but to file bankruptcy to get out of the loan, is that the lenders are now stuck with a home in disrepair. They’d then have to sell the house as-is to a short seller or at an auction, or they can invest the money themselves to repair the home.

When you take into account that the average cost of flood insurance is about $700 per year in the most expensive areas, that investment seems mighty worthwhile in comparison to fixing $25,000 or more worth of flood damage.

Mortgage insurance and flood insurance are two separate policies, just like homeowners insurance and flood insurance are two separate policies. But similar to homeowners insurance being paid through an escrow account held by your lender, flood insurance can also be paid through an escrow account, which is why it often gets mixed up with mortgage insurance.

The escrow account can actually pay for flood, homeowners and mortgage insurance, but you’ll still have separate policies for each. You’ll also still have to pay into your escrow account on a monthly basis, but doing so means you can pay monthly for a policy that may be due every six months or so.

Paying for flood insurance through an escrow account simply divides the payments into smaller portions. It doesn’t, however, give you the ability to combine policies or get a discount on your premiums.

Whether you’re getting flood insurance to satisfy your mortgage lender’s requirements or you’re getting it to satisfy your own sense of safety, you should buy flood insurance immediately and keep it effective all year long — not just during flood season.

With Clovered, all you need to do is fill out our online flood insurance quote form, which takes just a minute or two, and one of our many licensed agents will provide you with a quote that meets your needs and your budget.