When Gordon Casey bought his duplex in Syracuse's Skunk City neighborhood 10 years ago, he knew it was in a flood zone. And he didn't object to paying $325 a year for flood insurance to cover his $25,000 mortgage.
But over time, his mortgage was sold to different lenders, and each time, his flood coverage increased.
Then in December, things really got strange. He got a letter from his lender explaining that he needed coverage not for the balance of his mortgage, but for the amount it would cost to rebuild his entire house from scratch.
That cost? A surreal $237,349.
That's nearly 3 1/2 times the $68,000 market value of his house at 121 Hartson St., which sits in a neighborhood where nearly half the residents live in poverty. The house next door has been boarded up and vacant for the last two years.
To Casey, the idea of insuring his home for $237,349 is simply ridiculous. But his lender wouldn't budge.
This month, Casey, 59, whose main income is disability payments from a work-related illness, will begin paying $2,298 a year to insure his home — $1,478 for flood insurance and $820 for standard homeowner's insurance.
That's more than he pays for the mortgage.
"It's just hard to cope with," he said. "It's stressful for my wife and I."
Casey's predicament is no isolated case — in Syracuse or across the country. More and more homeowners in flood zones are getting caught in the same bind, with mortgage lenders pushing up coverage based on sky-high replacement costs.
It's a practice that some believe is illegal, but which has not been pursued aggressively by state or federal regulators.
"It's happening all over the place, and it's wrong," said Kai Richter, a Minneapolis attorney who has brought class-action lawsuits against mortgage lenders on behalf of tens of thousands of flood-zone homeowners across the country.
The trend could soon affect hundreds of additional homeowners in Syracuse. The Federal Emergency Management Agency is in the final stages of establishing a new flood zone along Onondaga Creek that would force more than 1,000 new property owners to buy flood insurance. The new zone contains some of the poorest neighborhoods in the city, where any increase in housing costs could have a devastating impact.
"We're talking about more than money here," Richter said. "For some people, we're literally talking about where they're going to be able to live, because a couple of hundred bucks a month is big-time money."
A neighborhood killer
As Casey and others have found, living in a flood zone is a lose-lose venture: You find yourself paying a lot more for a house worth a lot less.
Who would buy a house that carries a built-in fee every month for flood insurance, especially when that fee is skyrocketing?
Rich Puchalski, executive director of Syracuse United Neighbors, says the burden of flood insurance "destroys neighborhoods" because it discourages both new buyers and home renovations.
Thomas Zielinski agrees. He owns and rents out two houses on Hartson Street, both appraised at about $50,000.
"If I could get $20,000 for them, I'd think I died and went to heaven," he said. "You can't give them away."
Zielinski doesn't have flood insurance on either house. FEMA requires it only for homeowners in high-risk flood zones who have mortgages from federally regulated or insured lenders. Most mortgages fall into that category. But Zielinski has no mortgages — he bought his houses outright, in part so he wouldn't have to get the insurance.
He said he doubts that many homeowners in the zone have flood insurance. They are either landlords like himself who bought the houses outright or older residents who have long since paid off their mortgages.
David Capria, a landlord who owns the house at 509 Rowland St. in the flood zone, agrees. He said he thought about taking out a home equity loan to renovate the house, but decided it wasn't worth it because of the flood insurance. Anyway, why fix up a home you may never be able to sell?
Casey said he would love to buy out the $16,000 remaining on his mortgage and drop his flood insurance, but he can't afford it.
"If I'm going to pay this much, I might as well live in Manlius," he said.
Lenders make the call
FEMA created the National Flood Insurance Program in 1968 because private insurers were unwilling to take the risk. In 1973, the government required the insurance for homeowners in high-risk areas with federally connected mortgages.
High-risk areas are those that would be affected by a "100-year flood."
According to FEMA, homes in those areas face a 1 percent chance of flooding in a year.
FEMA requires only that affected homeowners buy enough flood insurance to cover the balance of their loan. But most lenders insist on far more.
"What we're seeing is that more and more lenders are requiring replacement cost coverage, which is putting a burden on a lot of people who have mortgages that are fairly low and people that are on fixed incomes," said Mary Colvin, FEMA's regional chief of flood plain management and flood insurance. "We absolutely have no control over that."
While FEMA sets the rates for flood insurance, mortgage lenders set their own standards for how much insurance their clients should have.
Casey's lender, Midland Mortgage — a division of MidFirst Bank in Oklahoma City — spelled out the difference in a Jan. 23 letter to Casey. It said the legal requirement for flood insurance coverage was the lowest of three options: the balance of the loan; the home's replacement cost; or $250,000, which is the maximum available from the government.
But it went on to say that Midland Mortgage has a stricter standard. Forget the balance of the loan — it's replacement cost that matters.
Brent Brethouwer, an insurance department representative with Midland, said the lender insists on replacement cost "to ensure that if the property sustained a total loss that our interests would be protected and the property rebuilt."
Lenders also point to a pamphlet from FEMA that advises them that basing flood insurance on full replacement costs is "a sound flood insurance risk management approach."
Richter, the Minneapolis attorney, counters that the pamphlet explicitly states that its guidelines should not be taken as legal advice. And he points out that the federal Department of Housing and Urban Development's lenders' guide touts the outstanding balance of the mortgage as the legal requirement for flood insurance coverage.
He says that for lenders to deny borrowers the option of using that minimum legal requirement violates long-held case law. His lawsuits argue that when lenders increase a borrower's insurance requirements, they are in effect changing the terms of the mortgage. That's even true if, as in Casey's case, the mortgage has been shifted from one lender to another.
"The way it seems to work is a deal is a deal is a deal, except when it comes to the bank wanting to change the deal," he said. "Just because the servicer changes, there's not some magical alchemy by which you get to change the terms of the mortgage."
Richter has filed class-action suits against five banks — Chase, Bank of America, U.S. Bank, Wells Fargo and RBS Citizens — that require coverage for replacement costs.
"The lender's insurable interest only goes as far as its financial stake in the property," he said. "Our argument is that that is limited to the borrower's principal balance."
Kickbacks alleged
The lawsuits allege that lenders benefit from requiring replacement value because they have "a commission or kickback relationship" with insurers.
If homeowners balk at buying replacement insurance, the lender can unilaterally charge them for the extra coverage by imposing "forced-place insurance." Such insurance is generally more expensive than traditional insurance — sometimes outrageously so. The lawsuits allege that insurance companies pay kickbacks to lenders when they impose that insurance.
Richter says state and federal regulators have not adequately addressed the abuses.
"It is something that's been kind of underneath the radar screen, but that doesn't mean that it's right," he said. "History is littered by all sorts of abuses by banks that have flown under the radar screen of state regulators."
A spokeswoman for the federal Consumer Financial Protection Bureau would not say whether the bureau has received any complaints on the matter or whether it was pursuing the issue in any way.
Ron Klug, a spokesman for the New York State Department of Financial Services, said he was unaware of any investigation of lenders inflating flood insurance requirements. He said lenders can require coverage at replacement cost value.
But he added that borrowers can refuse to buy flood insurance beyond the principal balance of the mortgage, as long as they acknowledge that it will cover only the loan, and not any flood damage.
Klug's department is looking into the larger issue of forced-place insurance and the relationships between insurance companies and lenders. The department says its initial findings suggest the high rates for the insurance are due partly to the generous commissions insurers provide to banks. Hearings will begin Thursday in Manhattan.
Such commissions can be highly profitable for banks. A January article in American Banker said that nationwide, banks' cut of forced-placed premiums "are almost certainly worth hundreds of millions of dollars."
Homeowners fight back
Some Central New York homeowners already have benefited from Richter's work.
Last year, a class-action suit he brought against Chase Home Finance and JPMorgan Chase Bank ended in a $10 million settlement that reduced insurance premiums for 50,000 homeowners across the country.
They included Donald Schmidt, who lives a few blocks away from Casey at 316 Rowland St.
Schmidt, 74, had not had flood insurance for years because his mortgage was paid off. But four years ago, he took out a home equity loan with Chase Home Finance to help his son buy a house. To use his own house as collateral he had to buy flood insurance. Chase said that insurance had to be based on his home's replacement cost.
His insurance company, Allstate, set the replacement cost of his $64,000 home at $174,000 and began charging him $1,229 a year for flood insurance.
Late last year, Schmidt got a letter from Richter's firm informing him that he was a beneficiary in the Chase settlement. Then Chase advised him that he could reduce his policy to cover only the outstanding amount of his loan.
That dropped his annual premium by two-thirds, to $409.
"That's a heck of a dip," he said.
What kind of replacement?
In Florida another attorney, Mark Beausoleil, is taking a different tack in his lawsuit against the state-run insurer, Citizens Property Insurance Co. His suit alleges that Citizens has been intentionally inflating replacement cost values.
Like Allstate, Citizens computes replacement values by feeding information about homes into a computer program. The lawsuit contends that Citizens manipulated the default values in the software so that it routinely assumes a house has expensive features like imported marble countertops or 10-foot ceilings. Those values combine to drive up the replacement values, Beausoleil contends.
"They're just saying to their policyholders: Here's your replacement cost value, and if you don't accept it, then we're not insuring you," he said.
Citizens has denied the allegations.
Mortgage lenders and insurers say it should be no surprise that the cost to rebuild a home from scratch can be so much higher than its current value, especially for older homes.
"If you're talking about a house that was built in the 1920s ... construction methods and materials have changed radically from then," said Tim Dodge, director of research and media relations for the DeWitt-based Independent Insurance Agents & Brokers of New York. "It's pretty extensive to rebuild a home with plaster and lathe and some of the intricate architectural finishes that probably went out of style years ago."
That standard can produce some eye-popping results, especially in Syracuse and other Upstate cities, where older homes are assigned replacement costs that dwarf their market value.
Allstate, like other insurance companies, pays no attention to market value when determining replacement costs. It does not matter, for instance, that Gordon Casey's home sits in a depressed neighborhood in a declining inner city. If the home were in a gilded enclave in Westchester County, the cost analysis would be much the same, give or take local construction costs.
What also frustrates Casey is that the only water problems he has experienced since living in the flood zone had nothing to do with an overflow from Harbor Creek or any other natural event. It was a city water main break in 2007 that filled his basement.
His ruined appliances were replaced by the city, not his flood insurance policy.
Even if a 100-year flood did hit the neighborhood and destroy his home — something Casey insists will never happen — he and his wife say there's no chance they would use their insurance money to rebuild.
"Imagine that," Joanne Casey said with a grim smile. "Would you put a $240,000 house here on Hartson Street?"
Contact Paul Riede at priede@syracuse.com or 470-3260.
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