Condo Financing: What You Need To Know

When you’re buying a condo, or if you already own one that you’re now going to sell, human nature is to assume that “everything is okay” with the condo project and homeowners association.  After all, the condo association board must be paying attention and doing everything they’re supposed to be doing in the best possible manner, right?

Not always.

If I was buying a condo, I’d want to make sure the condo project met all of the requirements of Fannie Mae, because Fannie Mae (and Freddie Mac) set the rules for 30-year fixed-rate loans (and 20-year fixed and most 15-year fixed and ARMs, too).  And what type of loan is most popular in America?  Yep, the 30-year fixed.

Even if I was paying cash, I’d want my condo project to be Fannie Mae-compatible because when I go to sell my unit, chances are high that my buyer will want a 30-year fixed-rate loan. The current Fannie Mae loan limit is $424,100 (as of 2017) in most parts of the country for condo’s, but a lot of jumbo money sources also follow Fannie Mae rules for condos, so it pays to know these basic facts on condo financing.

What makes a condo project Fannie Mae friendly?

The answer has two parts:

  1. How much documentation is the lender required to collect and review?
  2. Does the review reveal facts that are incompatible with Fannie Mae’s condo requirements?

The less digging and information that’s required for review, the less chance there is to find problems.  That doesn’t mean problems don’t exist regarding the condo’s compatibility with Fannie Mae requirements. Conversely, the more details you’re forced to or choose to examine, the greater the chance of finding a problem.

As a condo buyer or owner (or listing agent or buyer’s agent), how much do you want to know?  Most people prefer to assume “everything’s okay” because understanding the details of a condo project requires effort and can be confusing.  But for the intrepid readers who want to know more, here we go for our dive into the details of condo financing…

“Limited” vs a “Full” Condo Project Review

I’m providing a summary here, so if you want the actual granular details straight from Fannie Mae, click here. The key to whether a lender must perform a limited or a full condo project review depends on three factors:

  1. Is the condo an “established project” or a not?
  2. Down payment (or equity if a refi).
  3. Occupancy (primary residence, second/vacation home, or rental property).

“Limited Condo Review”

If the condo in an “established project” AND the buyer/owner will occupy the unit as a primary residence or second/vacation home AND is putting at least 10% down (or has 10% equity on a refi), the lender’s review of the condo project is going to be “limited.”  Luckily for lenders, most condo purchases and refinances fit into this category. Here’s a link to Fannie Mae’s limited condo review questionnaire with the actual details of the info the condo HOA will be asked to provide.

An “established project” is a condo project where:

  • At least 90% of units are sold and closed,
  • The project is 100% complete including all units and common areas, the project is not subject to additional phasing, and
  • Control of the HOA (homeowners association) has been turned over to the unit owners.

“Full Condo Review”

The following circumstances require a lender to perform a full review of the condo project if the loan will be sold to Fannie Mae or Freddie Mac, because these circumstances are viewed as being more risky:

  • The buyer/owner has or will have less than 10% equity, OR
  • The condo will or is being used as a rental property (regardless of down payment amount), OR
  • The project is not an “established project” (see definition above). For a “non-established project” to be eligible for Fannie Mae financing:
    • all of the common areas must be complete, and
    • all of the units in the project or in the subject property’s legal phase (if the project is being developed in phases) must be “substantially complete” which means drywall and windows are installed, and
    • 50% of the units in the project or subject legal phase must have been sold or under contract for sale to primary residence or second home purchasers.

The full condo project review involves gathering more documents from the association. If I was a listing agent, I’d gather these documents in advance and perhaps review them to sniff out potential problems.  On the other hand, maybe a listing agent doesn’t want to know about potential HOA problems, because then they’d have to disclose those adverse facts.  Yet the information could help a Seller decide if they should accept an offer with less than 10% down (which is one of the things that can trigger a full condo project review).  Here’s the “full review” list of condo documents:

  1. A longer condo questionnaire (provided by the lender to the association) that will determine if the condo project has features that make it ineligible for Fannie Mae financing.
  2. The current annual budget for the association – if the association is not setting aside at least 10% of its monthly income toward reserves, that’s a “fatal” problem. Reserves must be a line item in the budget. If a condo HOA has a current third-party reserve study that proves it already has adequate reserves, that can work in lieu of the “10% reserve rule” but I cannot ever recall this being the case.
  3. The bylaws of the association (look for things like deed restrictions or right of first refusal).
  4. Articles of Organization

What Makes a condo project ineligible for Fannie Mae financing?

If the lender’s review of the condo project, whether it’s a “limited” or “full” review, reveals any of the following features or conditions, the unit (and project) are not eligible for Fannie Mae financing:

  1. Inadequate master insurance coverage (see section below on insurance). This is the most common problem, even on projects that only require a limited review.
  2. There is any significant active or pending litigation involving the HOA, especially if the HOA is suing the developer.
  3. If more than one individual or entity (other than the developer on a non-established project) owns
    • more than 10% of the units in project with more than 20 units,
    • 3 or more units in a project with 5 to 20 units, or
    • 2 or more units in a project with 2 to 4 units.
  4. The HOA is not setting aside 10% of its monthly revenue toward a reserve fund (only typically gets discovered on a full condo review where a budget is required).
  5. If the project is not an established project and there are still units within the subject property’s legal phase that are not substantially complete or not enough units have been sold or are under contract to primary residence or second home owners.
  6. Commercial space (i.e., stores on the first level) in the project exceeds 25% of total project square footage.
  7. The project has any hotel/motel/resort features (like a rental / check-in desk), mandatory or voluntary rental-pooling arrangements, or other restrictions on the unit owner’s ability to occupy the unit. This is most common in resort areas, of course like Florida, Arizona, the Wisconsin Dells, etc.
  8. The HOA doesn’t practice basic financial safety practices like segregating the reserve funds from the operating account, requiring two signatures on checks from the reserve funds, etc.
  9. Deed or resale restrictions (e.g., the HOA has right of first refusal or imposes a fee upon the sale of a unit).
  10. The association requires a foreclosing lender to pay more than 6 months of delinquent HOA dues on the unit subject to foreclosure.
  11. The project includes manufactured homes.
  12. Mandatory fee-based memberships for using project amenities or services such as mandatory membership in a golf club (outside of the monthly HOA dues).
  13. Non-incidental income from business operations (e.g., the HOA owns and operates a restaurant or health club and makes a profit or loss from that business).
  14. The project offers supportive or continuing care for seniors or for residents with disabilities.
  15. More than 15% of unit owners are delinquent on their HOA dues (this was a big problem at the height of the financial crisis).

Are you worn out yet?  I hope not, because here are the important requirements for the insurance to cover the project, and it’s not rare for associations to have less coverage than Fannie Mae requires.  In most condo’s, the HOA insures the building, grounds and common areas, and the unit owners insurance the contents of their units.  Again, I’m only providing as summary here.  If you want the actual granular details, here’s a link.

The Big 5 Fannie Condo Insurance Requirements

  1. Replacement Cost Coverage – Every condo project must be insured to cover 100% of the cost to replace the project improvements, including the individual units should it be hit by a meteor (or other calamity) and destroyed or damaged.  In order to meet the Fannie Mae requirement, the policy must indicate it provides guaranteed replacement cost, extended replacement cost or have an inflation guard endorsement.  If the policy does not have this specific language or endorsement, then lenders need to get verification from the insurance agent that the coverage amount is reviewed annually with the HOA, and the coverage amount is adjusted accordingly to insure it remains equal to 100% replacement. The maximum deductible is 5% of the face amount of the policy.
  2. Building Ordinance or Law Endorsement – This endorsement insures against the increased cost of repairs or improvements that could be enforced by new codes or land use laws after a covered loss event occurs.
  3. Boiler and Machinery/Equipment Breakdown Endorsement – This endorsement is required to protect against loss of a project’s central heating or cooling blowing up.  The coverage amount should be equal the lesser of $2 million or the insurable value of the buildings housing the boiler or machinery.
  4. Severability or Interest/Separation of Insureds – This is required to be a part of the liability policy. It essentially provides the condo unit owner the ability to sue or file a claim against the HOA, even though they are a member of the HOA.
  5. Fidelity Bond (aka Crime or Employee Dishonesty) – Oddly, lenders only have to verify this type of insurance coverage if a Full Condo Review is required and the project has more than 20 units. Some Fannie Mae seller/servicers required proof of fidelity bond insurance even on limited reviews and for good reason. Fidelity bond insurance reimburses the HOA in the event of theft or embezzlement of HOA funds by HOA board members, management firms, etc. A requirement of these policies is for the HOA to verify it has some basic financial and book keeping safety practices in place. If I owned or was buying a condo, I’d want the HOA to have fidelity insurance, wouldn’t you?  And it’s cheap.  Yet many HOA’s don’t have it.

What if your condo project doesn’t meet Fannie Mae requirements?

Depending on the issue, Accunet Mortgage may have non-Fannie Mae money sources that can still fit the situation.  For example, if a single entity owns more than 10% but not more than 20% of the units in a project we have a money-source.  Or if the building in which your condo unit is located is substantially complete, but there are other buildings in the project that are still under construction, we have a loan program for that, too.  But it won’t be a 30-year fixed.  It will be an adjustable rate mortgage where the initial rate is fixed for 5, 7 or 10 years.

If you made it the end of this weighty tome, congratulations and thank you for learning more about the details of condo ownership and financing. There’s a lot more to it than meets the eye.

Give me a call at 262-252-5102 or drop me an email at brian@accunet.com if you have any questions or comments, or if you just want to brag that you made it to the end!