For every residential mortgage, the borrower’s creditworthiness and ability to repay must be underwritten and approved, and the appraisal must support the purchase price and be accepted by the underwriter. When you are purchasing a condo, there is an additional level of risk that must be analyzed and approved – the lender must verify the fiscal and physical health of the entire condo project into which you’re buying.
When buying a condo, it is a good idea to ask your real estate agent if the condo is warrantable. Your buyer’s agent should be able to get a general idea from the listing agent. Read on to understand what this means…
Most buyers prefer to use conventional mortgages to purchase condos because of the very attractive interest rates. These are the mortgages purchased by the two government-sponsored entities – Fannie Mae and Freddie Mac. The originating lender must do an evaluation to determine if the condo project meets Fannie Mae and Freddie Mac guidelines – and then must “warrant” this approval. And so the term warrantable is used to describe condominium projects and properties that meet Fannie and Freddie guidelines, and thus that Fannie and Freddie will purchase.
Financing condos got a lot tougher after the housing crisis / mortgage meltdown when there were many condo foreclosures, especially in markets where there was a great deal of real estate speculation. That’s when lenders found out the hard way that many condo projects were poorly managed, operating with poorly managed budgets and inadequate reserves, carrying inadequate insurance, inadequate fidelity bonds, had high levels of delinquency of hoa fees, and that the lender had very few rights in the event of a foreclosure.
The good news is that most condo associations properly addressed these issues once lenders focused attention on them. And with the housing market fully recovered and condo values climbing, mortgage lenders have loosened condo guidelines a bit as well.
The condo approval process requires that your homeowner’s association or property manager complete a detailed questionnaire and provide your lender with extensive documentation. You can expect them to charge a fee to provide this information, typically in the $100 to $250 range. Then the lender must analyze the information and determine if the condo meets Fannie Mae and Freddie Mac guidelines.
Some buyers seek to avoid the hassle of condo approval by purchasing a townhome instead. When you purchase a condo, you are really just buying the space from the paint inside the unit. A townhome is essentially an attached home – you own the walls of your unit and the land that your unit sits on. You also pay fees to a homeowner’s association that is responsible for neighborhood upkeep and use of neighborhood facilities. Townhomes are treated similarly to single-family residences by lenders and securing financing is similar to buying a detached home.
SOME KEY REQUIREMENTS FOR WARRANTABLE CONDOS
- Investor concentration – If purchasing a primary residence or second home – there are no requirements.
- Investor concentration – If purchasing a rental property – must be under 50% investor concentration.
- Commercial space – Must be less than 35 percent of the total building square footage.
- Budget – Must be operating at a positive on balance sheet and operating budget.
- Budget – Must have a 10% reserve line item IN THE BUDGET AS A LINE ITEM. Not 10% in reserves but 10% line item based on total Income received. If not 10%, a reserve study is an option.
- Insurance – Make sure master hazard insurance has coverage equal to 100% replacement cost and covers building ordinance/law or proof by insurance company cannot obtain in that market.
- Insurance – HO-6 is required with coverage equal to at least 20% of the property’s appraised value.
- Litigation – Make sure the homeowner’s association (HOA) is not named in any lawsuits
- Delinquency – Make sure no more than 15% of unit owners are over 60 days delinquent of HOA dues or assessments.
- Single Entity Ownership – Make sure no single individual, investor group, partnership or corporation own more than the maximum number of units allowed:
- Projects with 21+ units – 10% can be owned by one person or company
- Projects with 5 to 20 units – 2 units can be owned by one person or company
- Projects with 2 to 4 units – 1 unit can be owned by one person or company
- Confirm that the project has been completed.
- Confirm that the developer has turned over control of the HOA to the owners
- Confirm that the community does not allow short term rentals
- Condos in Resort Areas must pass an additional evaluation
IF YOUR CONDO IS NON-WARRANTABLE
Non-warrantable condo financing is unavailable via Fannie Mae, Freddie Mac, the FHA or the VA. If you are purchasing a condo in a project that is known to be non-warrantable, then the developer may be able to provide you with the name of a local bank that has agreed to provide financing – often at interest rates about 1% higher than for conventional mortgages. Small local banks, credit unions, and portfolio lenders are able to make their own rules and offer non-conforming mortgages. They don’t sell their loans to Fannie Mae and Freddie Mac, so they don’t need to conform to their guidelines – and they can make their own risk decision. And they may be willing to finance a non-warrantable condo, especially if the applicant is very strong and has a substantial down payment. Smaller local banks typically loan on these kinds of projects to support their local community.