A federal appeals court has ruled that banks can require a homeowner to buy flood insurance covering the full replacement value of a home rather than the amount of the mortgage loan.

The First Circuit Court of Appeals made that decision in Kolbe v. BAC Home Loans Servicing, LP.

The decision was handed down through a class action lawsuit where the named plaintiff, Stanley Kolbe, sued BAC Home Loans Servicing for damages alleged to have arisen out of the bank's requirement that he maintain flood insurance in an amount sufficient to cover the replacement value of his home, $250,000, rather than the amount of the loan, $197,437.

Kolbe contended that the bank cannot require more than the federally mandated minimum flood insurance, which is the lesser of the principal balance of the loan or $250, 000 in special flood hazard areas, and $0 in all other areas.

The court ruled otherwise.

Kolbe owns a home in Atlantic City, New Jersey in a special flood-hazard area. The loan was guaranteed by the Federal Housing Administration.

The district court granted the bank's motion to dismiss all claims, and Kolbe appealed.

A divided panel of the First Circuit later vacated the dismissal. The panel majority held that both Kolbe's interpretation and the bank's interpretation of the contract could be found reasonable by a trier of fact, and therefore that the district court erred in dismissing the breach of contract claim.

But, the full court granted a rehearing where it was concluded that the bank's reading of the text is the only plausible reading in the relevant context, according to Barry Zalma of Zalma Insurance Consultants.

The full court held that, for contract language mandated by a federal regulation that implicates the federal mortgage insurance and flood-insurance programs, this context includes the broader regulatory schemes and the federal policy underlying those schemes.

In essence, when this covenant is understood in context against its purposes and federal-housing policy, the only reasonable interpretation of this language is that offered by the bank, Zalma says in interpreting the full court's opinion.

Zalma says, “The result urged by Kolbe would seriously impair federal housing policy.” He says Kolbe's interpretation would prevent lenders from requiring adequate flood insurance, particularly for homeowners with mortgages above $250,000 (the maximum federal requirement) or homes outside of special flood-hazard areas, where the United States does not require any flood insurance.

Special Reports /

Court: Banks Can Require Flood Insurance Covering Full Replacement Value

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