Fannie Mae and Freddie Mac: 3 Property Insurance Requirements Often Confused
To common folk, Fannie Mae and Freddie Mac may sound like they’re two individuals you would find standing next to Minnie Pearl picking banjo on Hee-Haw.
To real estate companies, they’re government entities that work with lenders to help provide mortgages to residential buildings. For the lenders to offer these mortgages, they have to follow the guidelines Fannie and Freddie create – including insurance. The following explains three main property insurance items that are required and often times confused:
Coinsurance Clause Deleted- For property insurance, insurance carriers need to make sure they collect premiums based on the replacement cost of the building – not the depreciated value or the market value. One of the ways insurance carriers try to “encourage” this is to apply something called a coinsurance clause. This clause basically states – “If you don’t insure at least XX% of the replacement cost we’re going to only pay your claim based on the same discounted percent.”
Fannie and Freddie guidelines require that this clause must be deleted, or have the agreed-value clause or agreed amount endorsement be provided. Often times, the lender’s insurance department will get confused as the policy and certificate will have a coinsurance % listed with an agreed value endorsement attached. The agreed valued endorsement effectively suspends the coinsurance, thus the policy is in compliance with the requirement and just needs to be clarified with the lender.
Business Income Actual Loss Sustained- Lenders require property policies to include a limit for replacement of rents after a loss, as this is effectively the net operating income. This limit is called “business income with rents.” When this limit is on “actual loss sustained” this means that the payment for loss will be up to the limit as it is happening. This is as opposed to a structure with a maximum limitation and a monthly limitation.
Fannie and Freddie require “actual loss sustained for a minimum of 12 months” which typically is equal to the limit shown on the policy, as carriers base their business income rating on an annual period. Some lenders may ask for 18 months, which can be achieved with the actual loss sustained and utilizing the all location or blanket structure to make sure a full 18 months is available.
Extended Period of Indemnity– As noted above, the “business income with rents” pays the lost rents during the time it takes to repair the building. After the building is repaired, there will still be an amount of time when new tenants are being found and rents aren’t received. This period of time is called “extended period of indemnity” and some lenders confuse it with the period of indemnity.
Fannie and Freddie guidelines require 90 days for this extended period, however some lenders will request 180 days. To comply, this coverage just needs to be requested from the carrier, and the carriers will typically offer 365 days for a nominal charge, or even no charge.
By structuring the insurance policy to include the above items automatically, real estate companies will make it easier on themselves when securing financing through all lenders, but especially the ones representing your friendly Fannie and Freddie.
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