Wildfires aren’t just a homeowner problem; they’re a growing threat to lenders. As insurance companies pull out of high-risk areas and new laws put more financial burden on lenders, the old rules no longer apply. The days of assuming fire insurance will protect collateral are over.
Lenders are getting hit from all sides — insurance shortfalls, delayed claims and new laws that tie their hands. If their loan documents aren’t built for this reality, you’re the one taking the loss. While lenders can’t go back and rewrite existing loans, they can control how they structure deals moving forward.
If wildfire risks weren’t a priority before, they need to be now because the financial fallout from these disasters isn’t going away. Lenders who fail to update their loan documents and risk strategies could be the ones left paying the price. Mortgage originators who do business in California or any disaster-prone state should understand the business pressures their lending partners face and what can and should be done about it.
Escalating crisis
That million-dollar property might only be insured for $600,000 after depreciation kicks in. That gap isn’t just the borrower’s problem; it’s a direct hit to the lender when collateral values don’t match.
The wildfire insurance crisis is escalating, leaving lenders more exposed than ever. Major insurers such as State Farm and Allstate have stopped writing new policies in California, while others are quietly raising premiums, adding exclusions or canceling coverage altogether. Many borrowers are now stuck with the California FAIR Plan, an expensive last-resort policy with minimal coverage.
And even that coverage often falls short. Depreciation slashes payouts, co-insurance penalties reduce rebuilding funds and policy limitations mean many homeowners simply don’t get enough to restore their properties. When rebuilding isn’t financially feasible, borrowers walk away, leaving lenders to absorb the loss.
State Farm, California’s largest insurer, has already paid out $3.4 billion across 12,600 claims from the Palisades and Eaton fires. “We know we will ultimately pay out significantly more, as these fires will collectively be the costliest in the history of the company,” executives wrote to California’s insurance commissioner. As insurers absorb historic losses, premiums will keep rising and coverage will keep shrinking, pushing more risk onto lenders.
And it’s not just about underinsurance. Even when insurers agree to pay, funds are slow to arrive. California regulators take an average of 281 days to approve rate adjustments, dragging out claims for months. While homeowners wait, mortgage payments stop, properties sit vacant and lenders are left in limbo, facing massive losses with no clear timeline for recovery.
Even if some financial hits are absorbed, the work doesn’t stop there. As Bloomberg notes, “While some hits to the lenders may be temporary, untold man-hours will be needed to handle missed payments, work with borrowers and negotiate with insurers.”
Policy Band-Aids
As if insurance challenges were not enough, new laws are making it harder for lenders to recover after a wildfire. California Assembly Bill 238, currently under consideration, could require lenders to grant borrowers up to a year of forbearance, even if their home is a total loss and they have no plans to rebuild. Foreclosure restrictions and eviction bans are also making it more difficult for lenders to take back properties, extending losses over a much longer timeline.
Meanwhile, local building moratoriums and zoning restrictions are slowing down or even blocking reconstruction in some areas. If borrowers can’t rebuild, they may default, creating yet another layer of risk for lenders financing properties in wildfire-prone regions.
Gov. Gavin Newsom and Los Angeles Mayor Karen Bass are considering letting homeowners rebuild homes in their former, fire-prone areas, which will reduce the chances of the homes being insurable after they are rebuilt. Lenders are expected to absorb the financial fallout while Sacramento scrambles to fix the problem with policy Band-Aids.
“Right now, it’s like they’ve got the pedal all the way down to the floor on the speed side and not necessarily the deliberation side,” Andrew Rumbach, a senior fellow at the Urban Institute, told NBC News.
Rethinking strategy
Lenders who want to stay ahead of wildfire risk need to rethink their loan documents and underwriting practices. They also should tighten insurance requirements.
Loan agreements should mandate full replacement cost coverage — not actual cash value — so that depreciation doesn’t leave a property underinsured. Extended replacement cost policies, which provide 125% to 150% of rebuild value, can help cover rising construction costs.
The push for new borrower protections in wildfire-affected areas has left lenders with little room to maneuver. Some of these laws fail to distinguish between borrowers who face genuine hardship and those who simply take advantage of extended forbearance or foreclosure moratoriums.
Loan documents should include legislative carve-outs to ensure that only borrowers with a direct, verifiable financial impact from a wildfire qualify for special protections. This means clearly defining what constitutes financial hardship, requiring documented proof and ensuring that deferred interest is capitalized rather than forgiven.
Lenders also need clear default acceleration provisions in their loan agreements to handle abandoned or partially rebuilt properties. These provisions allow lenders to demand full repayment if a borrower is unwilling or unable to rebuild. This helps prevent drawn-out foreclosure battles and ensures lenders have an exit strategy when the property loses value or becomes insufficient as collateral.
At the same time, flexibility is important for borrowers who do intend to rebuild. Loan terms should allow for temporary interest-only payments during reconstruction, giving borrowers breathing room while ensuring lenders continue to collect payments.
Lenders should also have the discretion to require a deed-in-lieu of foreclosure if a borrower is unable to complete the rebuilding process. Lenders who do not have a strategy for claim disputes are setting themselves up for a fight they can’t afford to lose.
California’s wildfire crisis isn’t just a homeowner problem. It is a growing threat to lenders. Between insurance failures, legal restrictions and a shifting regulatory landscape, lenders who fail to act will find themselves exposed to significant losses.
