Should flood insurance costs affect home prices?

Consider a home buyer looking at two homes that are essentially the same in every way except for a significant difference in flood insurance costs. Clearly, the home with the higher flood insurance premium should be priced lower, since a new owner would have to pay an additional flood insurance cost on top of the mortgage and flood insurance cost of the first home. With everything else being equal, the rational buyer would choose the home with the lower total annual cost of ownership. With enough rational buyers, the market will adjust down the price of the home with the higher flood insurance rate until the two homes have the same total annual costs.

We can compare home values by comparing the monthly or annual costs of ownership, but how much cheaper should the home with the higher flood insurance costs be so it is fully competitive in the market? The price difference should be the net present value of the difference in annual flood insurance premiums.

In engineering, this type of comparison falls into the topic of “engineering economics”. There are equations that allow us to easily translate from a series of annual payments to the net present value of those payments, while taking into account the “time value of money”, i.e. the “discount rate” or relevant interest rate. This is similar to how monthly mortgage premiums are determined from a current loan cost, only in reverse. In this case, we want to determine the effect a series of annual flood insurance premium payments should have on a home’s value.

flood insurance home discount calculator

Click the button below to access the home discount calculator. This tool allows you to estimate the impact of higher flood insurance premiums. It determines the net present value of a series of increasing payments, where the payments are the difference in flood insurance premiums between two houses. It considers both that flood insurance rates are expected to go up at some annual growth rate, and that money in your hand today is more valuable than money guaranteed a year from now (“time value of money”).

I suggest your anticipated mortgage interest rate makes the most sense to use as the discount rate, because it is the rate you are agreeing to with your bank on the time value of money over the next 30 years.

The annual cost growth rate of insurance is a different story. In theory, it should be the actual rate of growth over the next 30 years. While FEMA is currently applying an 18% cap on year-to-year increases, this rate increase is meant to provide a more gradual transition to the full actuarial rates in Risk Rating 2.0, and should not be expected to be a long-term growth rate. Your current mortgage interest rate might be a better estimate, but of course it does not take into account any worsening of flood risk and actuarial insurance rates, as a result of climate change. Still it is probably a good place to start.

Read Your Risk maps flood insurance premiums to make it easier to find a home with acceptable flood insurance costs. See Sprinkles Flood Insurance Premium Estimate Maps.

Please comment and feel free to let me know if you would rather your comment not be made public. I review comments before they are published and would like to hear what you think either way.