December 17 2010 (Chris Moore)

In an attempt to lower its risks, the Federal Housing Authority (FHA) has been taking steps to tighten its underwriting practices that could severely cause a loss in value for condominium owners, making it harder for them to sell or refinance.

The FHA implemented new rules beginning in November of last year which will significantly reduce available condo financing and thus condo values. With condos less desirable, there will be more demand for single-family homes, something which should help bolster values for properties with one to four units.

The problem is, time is running out if your condo has not been approved. The ability to get your condo permitted ends on January 1st, 2011.

There are various forms of real estate ownership. Figures from the Census Bureau show there are 80 million detached single-family homes as well as almost 8.5 million condos. Fee simple properties of one to four units are the least risky for mortgage insurers because the borrower is good as long as he or she pays the mortgage, property taxes and insurance.

Condo’s on the other hand present a variety of additional risks:

– Along with the basic costs that a fee simple property owner pays, a condo owner must pay a condo or association fee. This is not necessarily a big expense, and it may actually be a smaller cost than the fee simple owner pays for exterior maintenance and repair. The catch is that a condo fee is a lien against the property. Don’t pay the association fee and your unit can be foreclosed.

– If the roof leaks and reserves are insufficient, then all units may face a “special assessment,” sometimes thousands of dollars. Like condo fees, special assessments are a lien against the property — don’t pay it and you can be foreclosed.

– If a number of unit owners are foreclosed and their condo fees are unpaid the association costs still have to be paid, the result is that then all remaining unit owners may face substantially higher condo fees. Units which were affordable in good times may suddenly become unaffordable because other owners cannot make their payments.

– If a large percentage of the units are rented then the entire property may be regarded as “investment real estate.” That hardly sounds important, but what it means is that ALL units in the project, including owner-occupied units, will need investor mortgages when sold or refinanced. Since investors face higher rates and tougher qualification standards, units requiring investor financing are harder to sell.

In order to qualify for FHA financing, condos must meet the following requirements for approval by the U.S. Department of Housing and Urban Development (HUD):

– No one person or entity can own more than 10 percent of the units
– Homeowner’s Association (HOA) must have adequate hazard, liability, and flood insurance
– No more than 30 percent of units can have financing with FHA loans
– Minimum 50 percent of units must be occupied by owners
– No more than 15 percent of unit owners can be delinquent on their association dues

The above restrictions are pretty straightforward. But these aren’t the ones that are giving condos headaches. It’s the financial requirements, which include:

– The condo must have a budget that’s deemed adequate by HUD
– The condo must have a reserve fund that’s at least 10 percent of the budget

And it’s the last rule that is the one that is so difficult to overcome because in many parts of the country, it’s common practice for condominiums not to have reserve funds. Instead, HOAs use assessments to pay for emergencies as they occur. While this may be a shortsighted method on the part of HOAs, many associations elect not to contribute money each year to a reserve fund for an emergency that may or may not occur.

So if your condo has not been approved, you still have one possibility: Your lender can go through the “spot approval” process. Some of the conditions for spot approval include:

– Building must be fully completed
– HOA must have adequate hazard, liability, and flood insurance
– Owners should have unrestricted right to use all facilities and common areas
– No legal restrictions on conveyance
– Condo must be 90 percent sold
– Minimum 51 percent of units should be occupied
– Only 10 percent of condo can have FHA loans if more than 20 units; 20 percent if under 30 units

Lenders are hoping, however, that the government will extend the deadline.

Tags: HOA, condominium, association, fha, underwriting practices, condo’s, lenders, reserve fund, association dues, financial requirements, HUD