Published on: November 19, 2009
If you thought the stricter standards Fannie Mae and Freddie Mac have established for condominium loans were causing headaches for community associations, you may want to increase your aspirin budget: The Department of Housing and Urban Development (HUD) has published new rules for condominium loans insured by the Federal Housing Administration (FHA) that could prove to be even more problematic than the secondary market guidelines now in effect. (You can read the FHA’s newly issued guidance on the condominium loan rules and recently announced changes in the requirements here.
Like the Fannie/Freddie guidelines, the FHA rules target underwriting lapses that bear a large part of the blame for the outsized delinquency rates and foreclosure losses with which mortgage lenders are struggling today. And also like the Fannie/Freddie guidelines, the FHA rules may have unintended negative impacts that policy-makers did not anticipate.
The new FHA requirements, announced in a recent letter to lenders, outline multiple changes in the standards condominiums must meet to be eligible for FHA financing. Three provisions in particular are causing concern:
- The FHA will no longer insure condominium loans individually on a “spot” approval basis; the community association must be certified as compliant with FHA standards and the certification must be renewed every two years.
- Community associations that do not meet specified financial requirements may have to obtain an annual reserve study, if the mortgage lender requests that update.
- The FHA will not insure a loan if more than 50 percent of the units in the community have FHA financing. (Responding to industry concerns, HUD agreed to increase the concentration limit temporarily from the 30 percent maximum originally proposed.)
Of all the FHA changes, it is the elimination of “spot loans” that is likely to create the most serious problems for community associations. Condominium buyers will no longer be able to obtain an FHA-insured loan unless the community association has a current FHA certification. “To address concerns involving the volatility in the condominium market,” HUD has agreed to waive implementation of this provision, which was to have taken effect immediately, until February 1, 2010.
The “concerns” to which HUD referred would more accurately be described as an outcry from lenders and condominium industry executives, who have warned that the elimination of the spot loan approval process will further disrupt an already fragile market.
Until recently, changes affecting FHA loans would not have been a major concern, because FHA financing (particularly appealing to lower-income and first-time buyers because of their small down payment requirements) did not represent a very large share of the mortgage market. But as underwriting requirements for conventional (Fannie Mae and Freddie Mac) loans have become more restrictive, buyers have been turning increasingly to the FHA. FHA-insured loans represented nearly 20 percent of the mortgages originated last year compared with only 5.5 percent in 2007. Communities lacking FHA approval will eliminate a large and growing pool of prospective condominium buyers.
Community associations can obtain FHA certification either directly from HUD or from an authorized FHA lender, under HUD’s delegated approval process. Once an approved lender certifies that a community meets the FHA standards, other lenders can rely on that certification to originate FHA loans, Patty Raymo, vice president and COO of Mortgagee Master, Inc. explains. That is convenient for other lenders, but it creates significant liability risks for the certifying lender – a burden that many lenders, especially smaller ones, may be unwilling to accept. As a result, Raymo predicts that many communities will seek certification directly from HUD, extending already lengthy review periods, and possibly overwhelming HUD’s already strained staffing levels. HUD developed the new FHA guidelines in part to streamline the condominium certification process, Raymo notes, but the elimination of spot loans is likely to have the opposite effect.
The new condominium loan standards originally required an annual reserve study for all community associations with no exceptions. That prospect upset condominium industry executives, to say the least — not only because reserve studies are expensive (and many communities decline to commission them, as a result), but also because, most agree, updating the study annually is unnecessary. The Community Associations Institute (CAI) made that point, among others, in a letter to HUD detailing the association’s multiple concerns about the FHA guidelines. The conditions affecting the estimated useful life and replacement requirement projections for a community’s buildings and key components, CAI noted, don’t change often enough to justify an annual review. (You can read the text of CAI’s comment letter here.)
Those arguments apparently had an impact. HUD revised the guideline to eliminate the annual reserve study if the association’s budget:
- Includes line item allocations ensuring that “sufficient” funds are available to maintain and preserve all “amenities and features” in the condominium.
- Calls for an annual contribution to the reserve account representing at least 10 percent of the association’s budget.
- Provides adequate funding for insurance coverage and deductibles.
Even for communities that do not meet these minimum standards, the revised FHA rules specify that the mortgagee “may” request an annual reserve study, but do not require the mortgagee to do so.
More problematic even than the annual reserve study the FHA guidelines originally mandated is the reserve funding requirement HUD’S regional office in Santa Ana has adopted. Under this policy, applicable only in markets within this office’s jurisdiction (Alaska, Arizona, California, Hawaii, Idaho, Nevada, Oregon and Washington state), a community’s reserve account must equal at least 60 percent of the funding levels indicated by the association’s most recent reserve study. If the study estimates that the community will have to replace its roof in 20 years at a cost of $100,000 and the roof is 10 years old, the reserve account would have to contain at least $30,000 (60 percent of $50,000) for that component. For condominium conversions, the Santa Ana office is setting reserve funding levels at 100 percent – in this example, that would mean a minimum of $50,000 in reserve account allocated for the roof alone.
Community associations subject to this requirement have good reason to be upset about it. When it takes effect later this year, one industry analyst predicted, “tens of thousands of condominiums will become virtually unsalable.” Fortunately, HUD’s other regional offices (including Philadelphia, which covers New England), have not followed Santa Ana’s lead, and Raymo, for one, doesn’t think they will. HUD’s concern about lending risks in California and Nevada is understandable, she says, given the severity of the real estate downturn there. But even so, Raymo thinks the Santa Ana reserve requirements will be viewed elsewhere as “extreme.”
The new Fannie Mae / Freddie Mac standards, which have themselves unnerved community associations, only require communities to allocate 10 percent of their operating budget each year for a reserve contribution; Fannie and Freddie don’t mandate a minimum reserve funding level, leaving in place the general requirement that associations have reserve funds “adequate” to meet their needs. FHA standards (other than in the Santa Ana region) call similarly for “adequate” reserve funding levels. Raymo says lenders have generally interpreted that to mean 10 percent of the reserve study recommendations, and HUD’s revised guidance doesn’t appear to change that rule-of-thumb.
They’re Not All Bad
Despite the considerable angst the FHA’s guidelines are generating within the common interest ownership community, some of the changes will be beneficial for condominiums. For example, the new rules will no longer prohibit FHA financing in associations that have the right of first refusal on the sale of units, as long as that process doesn’t violate HUD or FHA anti-discrimination policies. Additionally the FHA will now insure loans in communities with two- to four units, which were not previously eligible for FHA funding; and the rules will allow up to 25 percent of a community’s space to be allocated for commercial uses – a more flexible standard than the 20 percent maximum Fannie and Freddie have established.
Even the new concentration limits are an improvement. The FHA currently won’t insure a loan if more than 10 percent of the units in the community have FHA financing; the new rules increase that limit “temporarily” to 50 percent — the ceiling CAI had suggested — going up to 100 percent if a project “meets all of the basic condominium standards,” is 100 percent complete, and if construction has been completed for at least one year. The higher concentration limits will be in effect through December 30, but HUD has reserved the right to extend that date.
Wherever the concentration limits are set, it’s not clear who will be responsible for keeping track of them, or how. Information about which specific units in a condominium have FHA financing is not readily available, Raymo notes, so lenders are going to be asking community associations to provide those numbers.
Boards and association managers, already chafing at the amount of information lenders are demanding in connection with loans to purchase or refinance condominiums, are not likely to welcome these new requests or the additional costs and administrative burdens they will impose. And even if boards are willing to compile information about FHA financing in their communities, owners won’t necessarily be willing to provide it. More often than not, the answer to the question, “How many existing owners have FHA loans on their units?” will be – “We don’t know.”
Will the FHA reject loans if that information isn’t provided? We don’t know. And that is just one of many things we don’t know at this point about the FHA loan guidelines. They were to have taken effect October 1, but HUD has now delayed the effective date twice – first until November 2 and now until December 7. CAI has asked the agency to delay implementation for at least 120 days to solicit input from industry executives and study the impact on community associations and the housing market generally.
Raymo thinks the multiple implementation delays indicate that HUD officials didn’t anticipate many of the problems that lenders, CAI and other industry trade groups have identified, and are trying to determine how to address those concerns. “I don’t think the agency recognized the
HUD’s recently announced changes suggest that her assessment is correct. But while the agency has bent a little on some of the new loan standards, it has remained firm on most – including the certification requirement for community associations. The spot loan approval option won’t be eliminated immediately, but it is going to disappear. As a result, community association boards should seriously consider seeking FHA approval for their communities. Contacting lenders that have financed units within the community would be a good first step. Boards considering the FHA approval process should also talk to the association’s attorney about producing the legal opinion letter certifying lenders will probably require.
A board member attending a recent seminar outlining the new FHA condominium standards questioned whether certification is really necessary. Communities might be better off without FHA borrowers, she suggested, because they make smaller down payments and may be more at risk of defaulting on their loans (and their common area fees) than owners who obtain conventional mortgages requiring larger down payments.
That concern may be justified. But as noted earlier, FHA loans represent a significant and growing source of financing in the housing market. Associations that close that door, or fail to open it, will be limiting both the resale and refinancing options available to community residents, increasing the risk that financially troubled owners will default on their common area obligations.
Obtaining FHA certification will be expensive — we’d estimate between $3,000 and $4,000, though it’s hard to predict until HUD finalizes the rules. But precluding FHA financing may prove even more costly, for individual owners and for the community as a whole.