Week 1: Managing Disaster Debt - Financial Guide.

Disaster Debt refers to the additional financial obligations that a household takes on to recover from a major disaster.
Let's illustrate disaster debt in a scenario where a household is adequately insured, including flood coverage.

• Damage from wind, rain, and flood.
• Insured structure value: $350,000
• Flood insurance NFIP value: $250,000
• Mortgage: $200,000 (from a private lender under federal policy and controls)
• Estimated damage is 80%, labeled as substantial damage requiring reconstruction.

In this case, the initial step involves your flood insurance paying out the full amount with a two-party check, with your home's first lien holder (mortgage) listed on the check.
You'll endorse the check and pass it to your mortgage handler. Since they've already received a copy of the FEMA damage assessment, there's no need to rehash the estimated damages.
The only discussion you should have is what will the lender allow you to do? Reconstruct or Repair or; To safeguard the investment, your mortgage handler uses $200,000 of your $250,000 flood insurance to pay off your mortgage without further consultation. This is referred to as a "Forced Mortgage Payoff."
You receive a letter from your mortgage broker stating that your loan is now paid in full, along with the balance of $50,000 from the insurance proceeds.
Subsequently, your mortgage broker doesn't reach out again. Your account has been closed.
At this point, you find yourself without sufficient funds for reconstruction or repair. Although demolishing the home and obtaining a construction loan is an option, you won't qualify for any loan as long as the old structure remains in place and its collateral value is zero.
If you choose not to secure a grant for home reconstruction, your disaster debt burden would now manifest as a private loan. This loan's terms would be contingent on your discretionary income and your lands market value since you no longer have a structure to use for collateral..

Understand your Discretionary Income

Understanding discretionary income is crucial for managing personal finances effectively. Discretionary income refers to the amount of money a person has left after covering essential expenses like housing, utilities, groceries, and transportation. It represents the funds that can be allocated for non-essential expenses, such as entertainment, dining out, hobbies, SBA disaster loans, retirement funds and savings.

To calculate discretionary income, subtract total monthly essential expenses from total monthly income. The resulting figure is the amount available for discretionary spending and saving.

In the aftermath of a major disaster, understanding your discretionary income is pivotal for making well-informed financial choices regarding your recovery process. This knowledge enables you to allocate funds for crucial repairs and disaster-related expenses without resorting to additional debt, such as private or secured loans like an SBA disaster loan. It's important to note that taking on new loans should only be considered if you have at least 15% or more discretionary income after covering your regular expenses each month to include your new disaster loan payment. Additionally, caution should be exercised when considering an SBA loan offer, as it may use a simplistic method, like the "$50 in hand" approach, to determine your discretionary income. It's crucial to maintain a minimum of 15% discretionary income each month to avoid the risk of defaulting on any loans, particularly in times of crisis.

Review your Insurance Coverage

Your disaster debt burden can be calculated before a major event by reviewing your insurance coverage.

Examples of yearly insurance coverage reviews.

1. Review and adjust the estimated expense for replacing your home, include both demolition and the construction of a new residential structure.
2. Review any disaster mitigation requirements from your local municipality and state.
3. Review building codes established by the International Residential Code published by the International Code Council, Inc.
4. Research the cost per square foot for new construction of your home on the same footprint as your current home with mitigation and green building practices added into the costs.

The majority of homeowners may come to realize that their current insurance policies may not offer sufficient funds to cover the costs of constructing a new building that complies with current standards and regulations.

Insurance companies do provide options like "Extended" or "Guaranteed Replacement Cost" coverage, but it's important to note that you'll need to specifically request this type of policy coverage.

The National Flood Insurance Program offers a maximum of $250,000.
§4013. Nature and limitation of insurance coverage.
(2) in the case of any residential building designed for the occupancy of from 1 to 4 families for which the risk premium rate is determined in accordance with the provisions of section 4014(a)(1) of this title, additional flood insurance in excess of the limits specified in clause (i) of subparagraph (A) of paragraph (1) shall be made available, with respect to any single such building, up to an aggregate liability (including such limits specified in paragraph (1)(A)(i)) of $250,000;

If your $350,000 home flooded and needed to be replaced with new construction you would have to secure the outstanding or unmet needs of $100,000 before you could start your new construction.

The Federal Government does offer grant programs that can be used to assist homeowners in filling the gap between covered and not covered items. This gap coverage is called by HUD CDBG-DR grant program managers as unmet needs. Often unmet needs can be paid for by SBA loans then later reimbursed to the homeowners in the form of HUD Grants depending on state representation.

It's important to focus on Replacement Costs and New Construction costs and to verify these costs with local contractors adjusting for current market influance of materials and labor.

Guaranteed replacement cost insurance is available from select providers and would have been the perfect policy to have between 2019 and 2021 when material costs skyrocketed.
Between October 2019 and December 2021, lumber prices dramatically increased by near 60%.
Since then, lumber investment trading has dropped and lumber prices have returned to 2019 prices.
Numerous homeowners undertaking new construction during this period experienced significant material cost hikes, ranging from 35% to 60%.
During this period, labor costs within the industry remained stable, whereas contractors' overhead expenses and profit margins saw an increase.

It's crucial to ensure that your insurance policy covers the full cost of complete reconstruction in the event of a major disaster.

Additionally, understanding the steps for disaster assistance at both federal and state levels can help minimize the extra debt incurred during post-disaster rebuilding.
Please keep in mind that I can offer a general process, but it's important for you to adapt it to your specific needs.
For instance, in a major disaster like a flood that results in substantial damage to a residential home, flood hazard mitigation may drive the cost of rebuilding beyond the property's market value. Replacement funding is covered by the National Flood Insurance Program (NFIP) with a cap of $250,000. However, homeowners may not be aware of the need to secure extended insurance from private companies to bridge the gap between the NFIP maximum and the actual replacement cost. This is a critical consideration for comprehensive disaster preparedness.

In this case the homeowner has a few options.

1. Gather additional funds by using savings, retirement funds, private loans, borrowing from family.
2. Apply for federal financial assistance in the form of grants from state managed HUD CDBG-DR programs focused on long term disaster recovery.
3. Apply for a SBA Disaster Loan. Note: This may disqualify you from any HUD CDBG-DR grant program if you accept the loan. You can decline the SBA loan only if you do not sign and mail the loan acceptance.

In the example below, we'll set specific prices to use as constants.
Labor and Material costs as of 2022.

• Cost per square foot for building home. $118 per sqft.
• Cost of mitigation elevation in flood zone. $32 per sqft to 6'.
• Total economy grade build cost per square foot: $150.

Next, the square footage of your home will be utilized to compute the anticipated expenses for constructing a new replacement.
Using 1,500 sqft as average sized home.
1,500 * $150 = $225,000 to build a new home.
It's essential to demolish the old home, clear away the debris, and prepare the property for the new construction. This process may involve tasks like dirt work and leveling. On average, the cost for demolition is $18 per square foot of the structure.
This cost is then added to the overall expense of the new construction.
$150 + $18 = $168 per sq. ft.
Taking all factors into account, the final expenses amount to $252,000 for the new construction project, which includes mitigation measures for elevation.

If you had obtained the maximum amount of coverage from the National Flood Insurance Program, which is currently set at $250,000, you would only need to cover an additional $2,000 out of pocket assuming everything went perfectly.

You might be considering that the cost of building a new home at $168 per square foot doesn't align with the current market value of your property in a special flood hazard area. It's important to note that the evaluation of new construction costs versus market value are influenced by different factors and shouldn't be directly compared when making decisions about insurance coverage.
Having coverage that matches the first lien holder's amount doesn't automatically provide the extra funds necessary for constructing a new home.

As per federal policy, in cases where a home is substantially damaged, the first lien holders have the authority to apply your insurance payout towards the remaining loan balance. This could potentially result in receiving no insurance funding for rebuilding your home, while others might still have a balance remaining. This aspect is often overlooked when searching for Flood or Hazard insurance. For instance, having $250,000 in flood insurance while holding a $100,000 mortgage would leave you with $150,000 if you need to demolish and rebuild. The National Flood Insurance Program prioritizes satisfying mortgage liens on the home before it can be utilized as a financial resource for reconstruction.

Process steps:

• Calculate the total costs of replacing your home if substantially damaged.
• Match insurance policies to cover the actual cost of replacing your home.
• Add additional coverage if you have liens against the structure.

By now, you should have a clear understanding of the coverage amount you require. Your next responsibility is to seek out insurance companies that can provide the necessary services.

Quick Review of federal policy.

§4012a. Flood insurance purchase and compliance requirements and escrow accounts

(a) Amount and term of coverage

After the expiration of sixty days following December 31, 1973, no Federal officer or agency shall approve any financial assistance for acquisition or construction purposes for use in any area that has been identified by the Administrator as an area having special flood hazards and in which the sale of flood insurance has been made available under the National Flood Insurance Act of 1968 [42 U.S.C. 4001 et seq.], unless the building or mobile home and any personal property to which such financial assistance relates is covered by flood insurance in an amount at least equal to its development or project cost (less estimated land cost) or to the maximum limit of coverage made available with respect to the particular type of property under the National Flood Insurance Act of 1968, whichever is less: Provided, That if the financial assistance provided is in the form of a loan or an insurance or guaranty of a loan, the amount of flood insurance required need not exceed the outstanding principal balance of the loan and need not be required beyond the term of the loan. The requirement of maintaining flood insurance shall apply during the life of the property, regardless of transfer of ownership of such property.

This information is presented in Week 1 because it's probable that you weren't previously aware of the cost calculations. Now that you're informed, it's important to concentrate on this specific approach for your recovery. Conduct thorough research to help minimize the overall financial burden on your household during the disaster recovery process.

Most industry officials and government agencies that assist with new construction and rebuilding after a major disaster use industry software like Xactimate by Verisk Analytics, Inc.