Will homeowners’ insurance crisis upend home sales in California?

Every buyer should be asking the seller for an insurance pre-approval
or pre-qualification letter.

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | June 19, 2023

Article originally posted in Orange County Register on June 15, 2023.

She searched for two years to find the perfect pad. Last month Elaine L. finally found what she was looking for at the Canyon View Condominiums complex in Portola Hills.

Elaine’s offer was accepted. Escrow opened. Final mortgage approval was in process. Home inspection and appraisal were completed. HOA documents were ordered. Elaine’s mortgage application was denied because the condo seller’s association could not provide the required insurance coverage.

“It was just heartbreaking, absolutely horrible,” she said. Elaine, who was not a client of mine, told me she spent $2,000 on loan application fees.

Listing agent Gaelyn Goldsworthy of Bullock Russell was as shocked as Elaine to learn of the HOA insurance shortage. “The association had $9 million in coverage. The lender required $46 million,” Goldsworthy said. “Nobody is sounding the alarm.”

Elaine walked away from the sale.

My advice? From now on, every buyer should be asking the seller for an insurance pre-approval or pre-qualification letter for a specific property before plunking down expensive transaction fees like the $2,000 Elaine paid.

It’s not just homebuyers and sellers struggling to complete deals. Existing policyholders are on the wrong end of insurance policy cancellations and price spikes.

Last Sunday afternoon my wife happened to mention to me there was home insurance chatter and complaints on Nextdoor, a social media app. She agreed to post a note with my contact information inviting anyone wanting to share their homeowner’s insurance stories with me.

As a result of that post, I got 20 calls and texts within 48 hours. Most of them went something like this: “I’ve been insured with X company for many years without ever filing a claim. I received a drop-dead letter from my insurance carrier telling me I’m being canceled because I’m in a high-risk fire zone. I was able to obtain another policy through a different insurance company, but the price is now about double compared to my old insurance premium.”

I reached out to CalFire to ask what might have changed to prompt the insurance upheaval.

“We are in the process of adopting fire hazard severity zones in the state (for the areas we are responsible for),” said Jim McDougald, a division chief at Cal Fire Community Wildfire Preparedness and Mitigation Program. “The old maps have not changed yet.”

So, then why are many of our south Orange County neighbors (at least according to Nextdoor chatter) receiving cancellation notices and or paying more for new policies?

Insurers have their own risk and hazard models, according to McDougald. He strongly encourages stakeholders to read the FAQs about fire severity zones at osfm.fire.ca.gov.

In a nutshell, many insurance carriers argue the insurance premiums they charge California homeowners don’t come close to covering their costs to rebuild burned-down homes and commercial structures from the likes of natural disasters and catastrophic events. For example, global warming has helped to make California real estate incendiary fuel.

The insurance upheaval led State Farm and Allstate to halt writing new policies in California.

“State Farm is the ultimate canary in the coal mine,” said Dan Dunmoyer, president of the California Building Industry Association. “It’s the number one insurer… Thousands of condos aren’t being built until we solve the insurance crisis.”

Insurance Commissioner Lara has declined my repeated interview requests.

“To be clear, Californians are covered,” said Michael Soller, deputy commissioner for communications at the Department of Insurance. “Insurance companies are not leaving the state. This is hype that isn’t helping the situation.”

Dunmoyer at the builders association contends that the “slack is picked up by ankle-biters (non-admitted carriers and surplus lines) charging much higher premiums.”

Another last resort resource is the California Fair Plan. “It’s a stripped-down homeowners insurance policy requiring a companion policy,” said Wendy Holt of Holt Insurance. “It’s triple or quadruple the price of a regular policy.” Full disclosure: Wendy Holt is my insurance broker.

Lara and the state’s insurance department must respond to any rate increase request by insurers within six months. Dunmoyer alleges Lara has slow-walked approving any proposed rate increases.

“Lara grants the insurer maybe a 6% to 7% rate increase when the insurer needs a 20% increase,” Dunmoyer told me.

Here’s what economists told me about the California fire insurance crisis:

“Discouraging building in fire-dangerous areas is not a bad idea,” said Richard K. Green, director and chair of the USC Lusk Center for Real Estate. “People who don’t need it (fire insurance) are always the ones subsidizing the people that need it. Surely, this will matter (regarding home prices) at some point.”

“Homeowners in fire-prone areas will have to pay higher amounts (insurance premiums). Home prices in those areas will go down,” said Raymond Sfeir, economic research director at the A. Gary Anderson Center for Economic Research at Chapman University.

“This is a rapidly mounting issue across the country. This will impact sales prices. It’s a consequence of climate change. Political pressure will intensify. It will be a very painful and costly adjustment,” said Mark Zandi, chief economist at Moody’s Analytics.

“Eighteen months ago, I started hearing about fire insurance. Before that, it never came up. At some point, it will lead to (mortgage payment) delinquencies. Insurance carriers will make it prohibitively expensive to insure in areas prone to natural disasters,” said Michael Fratantoni, chief economist at the Mortgage Bankers Association.

About one-third of all U.S. homes are owned free and clear. Mortgage lenders mandate insurance for any mortgaged properties. Fannie Mae requires 100% replacement coverage.

Several folks I interviewed mentioned the idea of self-insuring your home. IRS Publication 547 is a good resource to address home damage and loss due to fires. Self-insuring comes with some caveats.

“Casualty losses are only deductible if the loss occurred because of a federally declared disaster,” said Warren Hennagin, CPA partner at Marcum. “You actually need to list the FEMA number on form 4684 to deduct the casualty loss.”

Freddie Mac rate news: The 30-year fixed rate averaged 6.69%, 2 basis points lower than last week. The 15-year fixed rate averaged 6.1%, 3 basis points higher than last week.

The Mortgage Bankers Association reported a 7.2% mortgage application increase from last week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $430 less than this week’s payment of $4,682.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 6%, a 15-year conventional at 5.75%, a 30-year conventional at 6.375%, a 15-year conventional high balance at 6.5% ($726,201 to $1,089,300), a 30-year high balance conventional at 7% and a jumbo 30-year fixed at 6.625%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.

Eye catcher loan program of the week: A 30-year FHA fixed rate at 5.5% with 2 points cost.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.