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House Bill 1338: Illegal Lender Insurance Requirements
by Kelly Troy on July 14th, 2009
Although you may not be aware of it, many lenders violate state law on a regular basis and very few closing officers, loan officers, or mortgage bankers even know that this law exists or that they are violating it. As a professional agent, I fight this battle several times a month (usually on the day of closing) and I have witnessed numerous loans delayed, at the closing table, because the lender wants to violate state law at the last minute. Most recently (four days prior to the writing of this article), I spent the the better part of an entire morning going ‘back and forth’ with the loan officer, the loan processor, the bank Vice-President, and finally, the bank President regarding a construction loan that was set to close. All parties were physically sitting at the closing table when the lender decided to delay closing in order to request an ILLEGAL increase in insurance to cover the amount of their loan. While most agents view selling insurance as a simple ‘transaction’ (like buying a gallon of milk) and they would have made the change and charged the customer more money, we at InsuranceForInvestors care about our clients and it is our job to act as consultants and advisors in order to ensure that they are treated ethically and that we always do what is in their best interest.
This is a continual issue that we insurance professionals must face on a regular basis and it shouldn’t even exist in the first place.
Unfortunately, one of the most frustrating aspects of insurance that we deal with on a regular basis is that of lenders or mortgagees illegally requiring their borrowers (a.k.a. our customers and clients) to obtain insurance coverage in the amount of the loan rather than for the actual replacement or reconstruction cost of the property.
THIS IS 100% ILLEGAL
While lenders may understand the ‘ins and outs’ of loan-to-value ratios, mortgage structures, amortization schedules, and everything else associated with the ‘money’ part of a mortgage loan, they know absolutely nothing about insurance, yet that doesn’t stop them from creating ridiculous requirements which violate state law and then demand that the borrower meet these requirements in order to get the loan. This is wrong.
From an insurance-only perspective, insurance companies don’t care anything about the market value of a property, its appraisal value, the purchase price, or the loan amount of the mortgage. These are all irrelevant. What insurance companies care about is the RECONSTRUCTION COST (also referred to as ‘Replacement Value’) of the property; or in other words, the amount of money that it is expected to cost to rebuild the property on the same land at today’s current labor and material rates (including soft costs such as debris removal, permitting, blueprints, etc). This has nothing whatsoever to do with the loan amount, market value or anything else.
As a simple example, let us assume that a new property is purchased (with an appraised value of $300,000) for an agreed-upon purchase price of $250,000. The buyer puts down 20% ($50,000) of his or her own money and then obtains a mortgage loan for the remaining balance, which is $200,000. The purchase price the buyer has agreed to pay (the original $250,000) includes the property itself, the land that the property is sitting on, and the seller’s equity. The buyer then contacts his or her insurance professional (hopefully us) and learns that the estimated reconstruction cost of the property is only $150,000 (this means that it is expected to cost $150,000 to rebuild the property in the event of a total loss and it does NOT include non-insurable items such as the land or the equity paid to the seller in the loan). The insurance binder is sent to the lender and the loan is ready to close. Sounds reasonable, right? Wrong.
More often than not, the lender will demand (yes, demand) that the insurance coverage be increased to $200,000 in order to cover the entire loan amount – which is where the ‘illegal’ part comes in. The lender is requiring the insurance company to provide coverage for the land, the seller’s equity, the rolled-in closing costs, and everything else associated with the loan even though this has nothing at all to do with replacing the property. Not only does it cost the buyer more money in insurance premiums, but it also violates state law.
HOUSE BILL 1338 (the Law)
House Bill 1338 was enacted into law by the Texas State Legislature on September 1, 2003 and it amends the Texas Insurance Code (to be more exact, it amended: Section 2, Article 21.48A, Insurance Code, Subsection (g)). Without rehashing all of the boring and dry ‘legalese’, the important part of this change states that:
“No Lender, as a condition of financing a residential mortgage or providing other financing arrangements for residential property, including a mobile or manufactured home, may require a Borrower to purchase homeowner’s insurance coverage, mobile or manufactured home insurance coverage, or other residential property insurance coverage in an amount that exceeds the replacement value of the dwelling and it’s contents, regardless of the amount of the mortgage or other financing arrangement entered into by the Borrower. A Lender may not include the fair market value of the land on which the dwelling is located in the replacement value of the dwelling and its contents.”
So you see, it is very clearly documented that the act of requiring Borrowers to ‘over insure’ their property in order to obtain a loan is illegal, but it happens much of the time and I myself, as a professional agent, have dealt with countless lenders who choose to argue the point and demand excess coverage, even after I have sent them a copy of this law, because it’s their own ‘internal policy’.
As a consumer, you should expect your agent to take care of this problem for you and, as a Borrower, you should demand that your lender follow the law (they would expect it of you) and report any who still withhold closing a loan based upon your obtaining insurance for their full loan amount.
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Unfortunately, I battle this on a weekly basis. Within the past 10 days of this comment, I have had a lender using their own warehouse line of funds blatantly state in writing that their management didn’t care what the law was, if the client was going to have the loan closed with them in the next few days they required the insurance to be in the amount of the loan itself regardless of the actual reconstruction cost of the home. This equated to intentionally over-insuring the property by almost $30,000. The client needed the loan and agreed to the excessive amount, but it’s just another example of uneducated loan officers and underwriters coupled with unprofessional and illegal lending standards.
I have fought with the lenders numerous of times regarding this. If you see the article (3/14/11) about BOA forcing people to buy higher insurance so they can benefit from the premium you will understand why. I hope some sue these lenders.
Kelly,
Does this law apply in North Carolina?
Cynthia
Kelly-
I’m so glad to see that other insurance professionals are taking notice of this. I can’t even count how many times I have also tried to protect my clients from being forced to over-insure upon closing. Perhaps lenders will start to make more of an effort to understand TXHB 1338 now that insurance company underwriters are closely comparing coverage limits written by the agent to what their own inspectors find.
Thank you!
Emily Walsh
Licensed Texas Insurance Agent