On The Case: Flood Insurance, Loan Caps, and the Prime Rate

by Robert CastonSeptember 28, 2016

I don’t live close to a river, but my lender says I still need flood insurance. Can he make me buy it?

House Flood
Short answer? Yes. If a lender says that you need flood insurance, then you must purchase it before you can get a loan. This may come as a shock to some people, especially those who don’t live near the ocean, a river, or a lake. But as you can imagine, since a lender is giving a borrower a significant amount of money to buy a home, they want to do everything they can to protect their investment. As we have seen in some areas, such as Louisiana, floods can strike areas unexpectedly, and in some cases both you and your lender would be grateful for the forethought. The Federal Emergency Management Agency has actually mapped out flood zones for the entire US, and they are based on the likelihood of an area experiencing a flood within 100 years. The fact is, flooding can take place just about anywhere, depending on the conditions. Underwriters follow this rule – there is a 25% chance that a home in a high-risk area will be flooded within the life of a 30-year fixed rate mortgage.

What are “loan caps?”

Loan Cap
Adjustable Rate Mortgages, or ARMs, can seem risky to some buyers, so to make them more palatable for borrowers, lenders provide “caps” or limits on how much the interest rate can change. A “periodic” cap is how much the loan can adjust in a shorter time frame, such as a year. A “lifetime cap” is how much the loan can adjust over the life of the entire loan. As you can imagine, this helps prevent the borrower from being subject to enormous swings in the interest rate and their monthly mortgage payments. One point to remember – the cap interest rates can go either way, up or down. So with an ARM, a borrower might actually experience a reduction in monthly payments if interest rates decline. In this case, the cap would protect the lender from losing too much on the loan.

I keep waiting for rates to go down before I lock in a loan. Someone suggested I watch the “Prime Rate.” What is that?

Prime Rate
The “Prime Rate” is the rate that most banks give to their top customers with a favorable credit history and/or other assets. This rate is generally used for ARM loans, home equity lines of credit, or credit cards. To follow this rate, The Wall Street Journal conducts a survey of the 30 largest banks in the US and then uses the rate posted by three-quarters of the banks. This is generally accepted as the national prime rate for lenders and borrowers to follow.

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About The Author
Robert Caston
Robert is a personal finance and business journalist with a bachelor's degree in journalism from Rowan University. He has more than 12 years experience in the online mortgage space. After purchasing a few homes himself over the years, Robert is determined to provide information that will help home buyers make it though the complex and ever-changing process of obtaining a mortgage.