New HOA Lending Rules

An already difficult condominium market is likely to become more challenging for buyers, sellers and lenders as a result of new underwriting guidelines adopted recently by Fannie Mae and Freddie Mac (the entities that buy most home mortgage loans). The revised rules respond to the mounting loan delinquencies and defaults that have bruised the bottom lines of just about everyone involved in financing residential mortgages. White this article is based on Fannie Mae’s new requirements; Freddie Mac’s are essentially the same.

The new policies require lenders to assess the financial strength of homeowner associations as well as the credit of the borrowers purchasing units in them. In addition to tightening the qualifying standards for condominium buyers, lenders must review the HOA finances which will, as an indirect result, push HOAs to focus more intently on their budgets and reserve policies than 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 Mae and Freddie Mac have provided automated reviews of condominium loans originated for sale to them.

Fannie Mae'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 (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 Mae wants lenders to perform full-scale rather than limited reviews on the condominium loans that it buys. The company also wants HOAs to be primarily owner-occupied. Fannie Mae 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 Mae that:

1.        The homeowner association has an “adequate” budget.

2.        The budget allocates at least 10% of annual revenues to reserves.

3.        The HOA holds funds equaling the deductible under the master insurance policy.

4.        No more than 15% of the common area fees are delinquents by more than one month.

All of these changes are significant for lenders, but the delinquency limit is likely to prove most problematic. Homeowner associations 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 Mae announced the new guidelines. Even with an aggressive collection policy in place, it takes time to collect delinquent payments or to foreclose on delinquent owners.

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 HOAs are already tripping over the new 15% 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.

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 HOA meets all of Fannie Mae’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 HOA's documents are in compliance, but for existing communities and smaller developments (2-4 units), Fannie Mae said the attorneys' review "need not rise to the level of a formal written legal opinion."

Fannie Mae 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

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 charge lenders for that work.

Having the attorney who represents the HOA or who prepared the original governing 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.

Homeowner associations will also feel the impact of the new condominium standards. They will have to respond to requests from lenders seeking to verify that they have they have an "adequate" budget, a 10% minimum reserve allocation and insurance deductible funding that the new rules require. It's not clear how lenders will determine that a budget is "adequate," but at a minimum, they will probably want copies of the budget and the most recent reserve study, plus some detailed background information explaining the reserve policies and reserve replacement history. 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 Fannie Mae policies will require HOAs not just to provide information, but to adopt policies they don't currently have. The reserve requirement will likely prove most challenging. Most HOAs do not have adequate reserves or a funding policy matching the replacement recommendations of a reserve study, which many also do not have. Many HOAs don't have any reserves at all. Few, have line items in their budget specifying that at least 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 Mae and Freddie Mac will not finance units in condominiums that do not meet the 10 percent-of-budget reserve requirement.

HOAs 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 HOAs are going to have to be serious about it too. Arguably, the new underwriting standards for condominiums will require lenders and homeowner associations to do things they should have been doing all along. HOAs will become stronger financially, lenders will adopt more prudent policies, and everyone will eventually end up in a better place as a result.

By Seth Emmer of Marcus, Errico, Emmer & Brooks, PC
Published in The Regenesis Report- September 2008

Provided by Jorel Association Management: September 2008