You have your heart set on purchasing a condo unit in sunny Florida. You also want a conventional mortgage for that unit. However, if the condominium project does not satisfy Fannie Mae guidelines, you will not qualify for a conventional loan.
Two common reasons why a condo project fails to satisfy Fannie Mae guidelines are (1) the condo is involved in litigation related to safety, structural soundness, habitability, or functional use; and (2) the homeowners association (HOA) has not set aside at least 10% of its budget for the funding of replacement reserves for capital expenditures and deferred maintenance.
The devil is in the details.
We discuss below the nuances of the litigation and budget hurdles.
Ultimately, if the condo project does not surpass these hurdles, you likely have a “nonwarrantable” condo on your hands, i.e., a condo that does not satisfy Fannie Mae guidelines. While you will not qualify for a conventional loan, you still have options. For 3 practical options on how to deal with nonwarrantable condos and how to find lending for them, read our guide here.
What types of litigation are deal breakers?
Here is the threshold question under Fannie Mae guidelines: Is the HOA, co-op corporation, project sponsor or developer named as a party in a pending litigation that relates to the safety, structural soundness, habitability, or functional use of the project?
If the answer is “Yes”: The condo is ineligible for conventional loans.
If the answer is “No”: The condo is eligible for conventional loans. However, the litigation must also be “minor,” which means it must also meet at least one of the following criteria:
- non-monetary litigation including, but not limited to neighbour disputes or rights of quiet enjoyment;
- litigation for which the insurance carrier has agreed to provide the defense, and the amount is covered by the HOA’s or co-op corporation’s insurance;
- the HOA or co-op corporation is the plaintiff in the litigation and upon investigation and analysis the lender has reasonably determined the matter is minor and will result in an insignificant impact to the financial stability of the project;
- the reasonably anticipated or known damages and legal expenses are not expected to exceed 10% of the project’s funded reserves;
- the HOA or co-op corporation is seeking recovery of funds for issues that have already been remediated, repaired, or replaced and there is no anticipated material adverse impact to the HOA or co-op corporation if funds are not recovered;
- litigation concerning localized damage to a unit in the project that does not impact the overall safety, structural soundness, habitability, or functional use of the project; or
- the HOA or co-op corporation is named as the plaintiff in a foreclosure action, or as a plaintiff in an action for past due HOA or co-op assessments.
The above list of what constitutes “minor” litigation is good news if you are hoping your condo qualifies for a conventional loan. Fannie Mae announced the expanded list in January 2018 to allow more flexibility when considering what qualifies as acceptable, minor litigation.
In January 2018, Fannie Mae also clarified its policy as to litigation involving death or injury, as well as litigation for construction defects:
- Litigation that involves personal injury or death does not meet Fannie Mae’s criteria for minor litigation unless (1) the claim amount is reasonably anticipated or known; (2) the insurance carrier has agreed to provide the defense; and (3) the reasonably anticipated or known damages are covered by the HOA’s or co-op corporation’s insurance.
- Construction defect litigation in which the HOA or co-op corporation is the plaintiff are not considered a minor matter unless the HOA or co-op corporation is seeking recovery of funds for issues that have already been remediated, repaired, or replaced. In addition, there is no anticipated material adverse impact to the HOA or co-op if the funds are not recovered.
Bottom line regarding litigation: Gather as much information as you can regarding the pending litigation. Analyze closely whether the litigation really involves any of the buzzwords – “safety, structural soundness, habitability, or functional use.” If it does, you will likely find it difficult to obtain conventional financing. If it does not, you are in better shape of convincing the lender the litigation is “minor” and therefore acceptable.
What are the budgetary requirements that the condo project must satisfy?
Fannie Mae requires the lender to determine that the HOA budget is adequate and that it provides for the funding of replacement reserves for capital expenditures and deferred maintenance that is at least 10% of the budget.
Here are three helpful tips to keep in mind regarding the 10% reserves requirement:
- Tip #1: The following types of income may be excluded from the reserve calculation (and therefore boost your chances of meeting the 10% threshold requirement): (1) incidental income on which the project does not rely for ongoing operations, maintenance, or capital improvements; (2) income collected for utilities that would typically be paid by individual unit owners, such as cable TV or Internet access; (3) income allocated to reserve accounts; and (4) special assessment income.
- Tip #2: If you do not think your condo will satisfy the 10% reserves requirement, you can ask your lender to submit the condo under the “Limited Review” process, which, unlike the “Full Review” process, does not have the 10% reserves requirement. However, in order to be eligible for a Limited Review, the unit must be in an established condo project (as opposed to a new condo project).
- Tip #3: Another way to avoid the 10% reserves requirement is to look for a lender that has a lower hurdle. For example, some non-QM lenders are willing to accept 8% instead of 10% for reserves. A mortgage broker can help connect you with such lenders.
Bottom line regarding budget: It may be difficult to satisfy the 10% reserves requirement, but there are alternative options, including asking for a “Limited Review” or finding a lender that has less stringent reserves requirements.
To learn more about how to obtain a mortgage for condominiums, including non warrantable condos in Florida, read our guide here.
David A. Krebs is a licensed mortgage broker offering commercial and residential loan programs beyond your regular bank. Call us at 321-239-2781, click here to submit a message, or click here to book a free consultation.