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New Condominium Guidelines Demand More from Lenders and
Community Associations
By Seth Emmer
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An
already difficult condominium market is likely to become more
challenging for buyers, sellers, and especially for lenders as a
result of new underwriting guidelines adopted recently by Fannie Mae
and mirrored, in key respects, by Freddie Mac. The revised rules
respond to the mounting loan delinquencies and defaults that have
bruised the bottom lines of Fannie, Freddie, and just about everyone
else involved in financing residential mortgages. But the new
policies also reflect concerns — long-standing, though not often
enforced aggressively in the past — about the need for lenders to
assess the financial strength of community associations as well as
the credit profile of the borrowers purchasing units in them. In
addition to tightening the qualifying standards for condominium
buyers, the new rules will require lenders to assume more
responsibility for reviewing the finances of community associations
and will, as an indirect result, push community associations to
focus more intently on their budgets and their reserve policies than
many have tended to do in the past.
Full Reviews Required
For
lenders, the most significant procedural change is the virtual
elimination of the streamlined “spot” loan approval process through
which Fannie and Freddie have provided automated reviews of
condominium loans originated for sale to them. (This article is
based on an analysis of Fannie Mae’s policy announcement, but as
noted earlier, Freddie Mac’s new requirements are essentially the
same.) Fannie’s new rules will require full project reviews for
loans to individuals purchasing units (for primary residences or
second homes) in new condominium developments and for loans to
investors buying units in both new and established communities.
Lenders financing multiple loans in existing communities – defined
as more than one loan in a given community within a year – will have
to subject those loans to a full project review as well. Spot loans
— single loans in existing communities —will be allowed only for
borrowers making a minimum down payment of 10 percent – another
significant change from the former policy, which allowed 100 percent
financing for some condominium loans. Clearly, Fannie wants lenders
to perform full-scale rather than limited reviews on most of the
condominium loans the company buys. The company also wants
communities to be primarily owner-occupied. Fannie will not approve
an investor loan unless at least 51 percent of the units are owned
or (in a new development) under contract to owner-occupants or
second-home owners. Under the full project review now required for
most condominium loans, lenders must verify and warrant to Fannie
that:
 | The community association has
an “adequate” budget. |
 | The
budget contains a line item allocating 10 percent of
annual revenues for the association’s reserves |
 | The association has available
funds equaling the deductible under the association’s
master insurance policy. |
 | No more than 15 percent of the
common area fees are delinquent by more than one month.
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Limits on Delinquencies
All of these changes are significant for lenders, but the
delinquency limit is likely to prove most problematic. Community
associations in Massachusetts and nationwide are already struggling
with rising delinquencies and foreclosures, exacerbated by a
weakening economy and restrictive lending policies that had already
begun to tighten before Fannie announced the new guidelines. Even
with an aggressive collection policy in place, it takes time for a
community association to collect delinquent payments or to foreclose
on delinquent owners. In Massachusetts, associations can’t even
begin the collection process under the state’s super lien statute
until an owner has fallen two months in arrears. Lenders,
struggling with delinquency overloads themselves and under pressure
to work with struggling borrowers, are delaying foreclosure actions
and (in turn) delaying the point at which they must assume
responsibility for paying the fees for the units they acquire.
Under these circumstances, it is likely that large numbers of
associations are already tripping over the new 15 percent
delinquency requirement, or will be soon. The full impact is
unclear, but at a minimum, this policy seems to be at odds with
federal and state efforts to stimulate the sagging housing market.
The policy also seems inconsistent with another recent Fannie Mae
announcement telling loan servicers that they can increase the
forbearance period on delinquent loans from four to six months, to
give borrowers more time to seek financing alternatives that will
allow them to avoid foreclosure. (I asked Fannie Mae officials if
they have considered some of these potential problems, but hadn’t
gotten a response as of this writing.) The new guidelines will
increase the paperwork and expand the potential liability for
lenders, who must now warrant on each condominium loan sold to
Fannie Mae that the community association meets all of Fannie’s
legal requirements. In a follow-up memorandum clarifying the
policy, Fannie Mae explained that for new condominiums, lenders must
submit a formal written opinion from an attorney verifying that the
association’s documents are in compliance, but for existing
communities and smaller developments (two-to-four units), Fannie
said, the attorneys’ review “need not rise to the level of a formal
written legal opinion.”
Distinction
without a Difference
In theory, Fannie seems to be suggesting that the
review for existing communities will be less extensive; in practice,
however, this will be a distinction without a difference. No lender
is going to warrant compliance for a new or existing development
without obtaining an attorney’s written opinion on which to rely.
And no attorney is going to provide that written opinion – whatever
it’s called – without performing the analysis necessary to offer an
informed assessment. Whether they are dealing with a new
development or an existing community, attorneys are going to have to
review and analyze the association’s documents, and they are going
to charge lenders for that work. Having the attorney who represents
the association or who prepared the original documents perform the
review may reduce the cost, but there will be legal fees involved
and lenders will almost certainly pass those expenses along to
borrowers, increasing the cost of condominium loans. Community
associations will also feel the impact of the new condominium
standards, in two ways. First, they will have to respond to requests
from lenders seeking to verify that they have they have the
“adequate” budget, 10 percent reserve allocation, and deductible
funding the new rules require. It’s not clear how lenders will
determine that an association’s budget is “adequate,” but at a
minimum, they will probably want copies of the budget and most
recent reserve study, plus some fairly detailed background
information explaining the community’s reserve policies and its
reserve replacement history. Association boards should anticipate
these requests and develop policies for dealing with them. Owners
should anticipate that boards will require them to pay for the
reasonable cost of providing the information requested by lenders
financing the units owners are trying to sell.
Pushing for Reserves
The new condominium policies will require
community associations not just to provide information about their
policies, but in many cases, to adopt policies they don’t currently
have. Fannie clearly wants homeowners associations to have budgets
(preferably “adequate” ones), to maintain reserves for replacing
major building components, and to have the capacity to cover their
insurance deductible. Among these, the reserve requirement will
likely prove most challenging. Most communities do not have
adequate reserves – defined as existing savings and a funding policy
matching the replacement recommendations in the association’s
reserve study, which many also do not have; some communities don’t
have any reserves at all; few, if any, have line items in their
budget specifying that 10 percent of their annual revenues will be
allocated for the reserve account. But here’s the critical bottom
line: Lenders selling loans to Fannie and Freddie will not finance
units in condominium communities that do not meet the 10 percent
-of-budget reserve requirement. Associations may be able to win a
waiver if they can demonstrate that their reserve study supports a
lower reserve to budget ratio. But Fannie Mae is serious about the
reserve requirement and associations are going to have to be serious
about it, too. Arguably, the new underwriting standards for
condominiums will require lenders and community associations to do
things they should have been doing all along – associations may
become stronger financially, lenders may adopt more prudent
policies, and everyone – lenders, associations, condominium buyers
and sellers – may eventually end up in a better place as a result.
But the trip from where we are to where these policies are driving
us is going to be bumpy at best, and it is unlikely that anyone is
going to enjoy the ride.
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