New FHA Condominium Guidelines–What You Need to Know

In February of this year, the FHA passed a new set of lending guidelines that significantly changes how condominium units are approved for FHA-backed loans. It’s important for condo owners and board members to understand these new guidelines and how they impact your community. I’m going to provide a bunch of background information, so if you’re perhaps a real estate agent who is well versed in FHA procedure, you can skip ahead a bit.

The Federal Housing Administration is a government agency created during the Depression (now part of Housing and Urban Development) that provides mortgage insurance on loans. It’s a common misconception, but the FHA does not actually loan money or create loans. Instead, it insures private lenders that their loans will not fail. In exchange, FHA approved loans often have consumer friendly terms (though, not as “friendly as the Adjustable Rate Mortgages that were popular before the housing crash). FHA loans are extremely popular–as many as 25% of the loans in the United States are FHA-approved loans.

Until February of 2010, a lender could get spot approval of a loan on a single condominium unit if the building was not on FHA’s list of certified properties. However, as of February 1, 2010, the FHA has removed the spot approval process entirely. Now, the only way to get an FHA loan for a condominium purchase is if the entire project/building has been pre-approved by the FHA, either because the bank or the condominium has submitted the necessary paperwork.

First of all, this raises an important issue for board members. If you want to encourage sales in your building (and any smart board member should want to encourage a robust resale market), you have to make sure that your association is preparing the required forms for FHA approval. If your condominium is not FHA approved, you are potentially removing 25% of the market for units.

The tremendous problem, however, is the FHA guidelines themselves. It is certain that a huge number of condominium projects, perhaps even a majority, will not satisfy the very stringent new requirements for becoming an FHA approved property. And, unlike in the past, there will be no way for a buyer to get approval for a single unit. Here are some of the new guidelines, and why they are problematic:

1) Maintain a reserve equal to 10% of the annual budget: Even completely healthy condominium properties often fail to maintain a reserve of this size, and in many states condominium owners may chose to waive collection of reserves entirely. A truly distressed property, one that needs the government’s help, will never be able to budget for basic services (like water and garbage) and still maintain appropriate reserves. Reserves are kept for emergencies—many communities have actually used their reserves to weather the current crisis.

2) Make sure that no more than 15% of owners are more than 30 days late on condominium fees: Again, this is a guideline that seems ignorant of reality—in the current economic environment, even healthy properties can have delinquency rates over 15%, and the vast majority of distressed condominiums will never reach this threshold. There are struggling-but-functional condominiums in the country today where over half of the units do not pay maintenance, but the solution to this problem is to get the abandoned units into the hands of new buyers—not to preclude the entire property from one of the country’s most popular loan programs. This single guideline realistically exempts every single property that the government desperately needs to assist.

3) Assure that no more than 10% of the unit are held by a single investor: Not only is this guideline misguided, but it conflicts with the current trend in state law, where states are actually making it easier for investors to buy large numbers of unsold units. Abandoned or empty, ownerless properties contribute nothing to a condominium, and force the other owners to foot the bill. When investor-owners purchase large blocks of units in distressed condominiums, they have legal responsibilities to pay maintenance on those units and contribute to the upkeep of the property. That’s a good outcome for distressed communities—the FHA guideline, which would block this practice, is perplexing.

4) Have no more than 25% of the space used for commercial activity: Many extremely successful condominiums, especially in large cities like New York, are designed with large percentages of commercial space–the rents paid can reduce dramatically the maintenance load on owners. The commercial owners attract buyers to the condominium, particularly those who appreciate the convenience of having in-building amenities like restaurants, shopping and entertainment. Again, this guideline appears to ignore marketplace realities and blocks help for distressed properties that could otherwise be quite successful.

There are FHA guidelines that are quite reasonable–such as allowing access to financial records or requiring fidelity insurance. And the FHA has clearly passed these rules because it believes it is protecting the government from insuring bad mortgages, or at least mortgages in properties that it believes will fail. But the government, through the FHA, is using a butterfly bandage to close a gaping wound. The condo market has already crashed and failed–the government needs to provide tools that will allow investors, buyers and agents to sell the backlog of empty units and replenish the coffers of shared ownership communities. It should not be passing regulations that will make it even more difficult for buyers to clear real estate stock. And these new FHA guidelines will make it so difficult for some condominiums to move their empty or unsold units that the communities will be destined to fail. Like the earlier Freddie Mac/Fannie Mae guidelines, the new FHA guidelines are misguided, don’t respect the realities of the current marketplace and in the long run will hurt buyers, instead of encouraging them.

UPDATE: I sent a letter to HUD asking them how a condo may file for pre-approval. Unless I’m misreading their response, it appears that any approval must be done through an FHA approved lender, which certainly makes the process far more arduous:

“Please read Mortgagee Letters 2009-46a and 2009-46b that all apply to change is the approval method of condominiums. You can access the Mortgagee Letters at the following URL:

http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/

Under the new rules that took effect December 7, 2009, there are two approval methods; HRAP (HUD Review and Approval Process) and DELRAP (Direct Endorsement Lender Review and Approval Process).

Condominiums approval under HRAP/DELRAP must be submitted by an FHA approved lender, thus cannot be done by an individual, HOA, etc. So if you are not a lender, you will need to enlist the help of an FHA approved lender to get your condominium FHA approved. If you are a unconditional DE approved lender with FHA, then you should use the DELRAP approval unless the condominium meets conditions specified in the Mortgagee Letters. If you are not a unconditional DE approved lender (i.e. a broker, builder, part of the HOA of the development, etc.), then you must go through the HRAP process. For information on how to submit condominiums for approval via the HRAP process, please contact the Home Ownership Center (HOC) in your region for information due to this e-mail address is geared for the technical support of the FHA Connection website. To reach the HOC, please call 1-800-CALL-FHA (1-800-225-5342) or e-mail info@fhaoutreach.com.

As for the DELRAP process, we are able to provide instructions for that process since that is done on the FHA Connection website. If you meet the requirements stated in the Mortgagee Letters, the first thing that you need to confirm is that you have the “Condominium Approval Maintenance” authorization set to “Update” on your FHA Connection user ID. If you are not sure, the application coordinator in your company can check if it is set and set it if it is not.

Once that authorization is set, do a query in the Condominiums function where you get the error saying “No Record Match Your Selection Criteria”. When you get that error and you have the authorization mentioned set, you will also see a “Establish Condominium Project” button. You would click that button and complete the form that comes up to submit the condominium for approval. You would complete that form and you will find a field on that where you point to where the PDF file is located on your computer for recorded documents and another field where you point to where the PDF file is located on your computer for unrecorded documents.”

I’ll keep researching this and report back when I know more.

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