What's the best strategy around flood insurance?

Question

I'm a first time investor who recently purchased a duplex in a FEMA flood zone. The numbers still penciled out really well even with the flood insurance, and I was even able to find some private coverage that ended up cheaper than NFIP. Even still, flood coverage alone is about $3,000 per year on this property.

I was listening to a recent episode of the Rookie podcast and both hosts mentioned that if they had a property in a flood zone they would prioritize paying it off so that they could drop the bank-mandated flood coverage. To be honest that was surprising to me since it seems like a worthwhile cost to protect the investment regardless- so long as the underwriting takes it into account and the deal works even at conservative numbers.

I've been thinking about it a lot though. We owe about $160,000 on the mortgage and in theory we could pay this property off entirely which would free up significant cash flow ($800ish/mo on the mortgage and another $250/mo to drop the flood coverage). Seems really risky to me though. Anyone have some insight they could share about how they think about flood insurance on their properties?

Michael Eskenasy · Answer

Bill — I wouldn’t pay off a $160K mortgage just to earn the right to self-insure a flood risk.

Those are two different decisions.

Paying off the loan should be evaluated based on the return you get from eliminating the debt, what else that $160K could be doing, and how much liquidity you want tied up in one duplex.

Flood insurance should be evaluated based on the risk you’re transferring for the premium.

The bank requiring the policy doesn’t make the underlying flood risk disappear when the mortgage does.

In fact, once the property is paid off you’d have more equity exposed to the same flood.

If $3,000/year makes the deal stop working, I’d question the deal. But if you already underwrote the property with that expense and it still produces the return you want,

I personally wouldn’t rush to remove the protection just because the lender no longer forces me to carry it.

I’d also be careful looking at the $800 mortgage payment as $800/month of “savings.” Part of that payment is principal, which is just moving money from cash into equity.

The real comparison is:

What return do I get by putting another $160K into this property versus keeping that capital available elsewhere?

Then separately:

Am I comfortable personally absorbing the flood loss if the bad year comes?

If the answer to the second question is no, I’d keep the coverage.

I don’t think “the bank stopped requiring it” is an investment thesis.