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What’s Happening with Condo Loans –
Is Financing in Serious Jeopardy?

There are a number of indicators suggesting that financing for condominium associations may be in serious jeopardy. Indeed, financing for any owner occupied real estate purchase or refinance is tighter than it has been in years for many reasons, but because of recent changes in the FHA certification processes, condos seem to be a heavier hit than other common interest development properties. (“Site condominiums” which are those stand alone units and not part of attached housing do not fall into the group of condos that is the subject of this article.)

Condo loans are jeopardized by new FHA regulations, and so let’s start with a few words about the Federal Housing Authority (FHA). Understanding the FHA and how it works is helpful. The FHA helps lenders reduce their exposure to bad loans (those that go into default and foreclosure) by providing mortgage insurance. This backup protection allows lenders to make financing available to borrowers at a lower-cost and a lower down payment than many of the “conventional” financing options available (although the FHA up front costs and down payment requirements are increasing in 2010). The FHA is a critical provider important to the overall health of the housing industry. There has been considerably more reliance on FHA loans during the current economic downturn because the ability of private lenders to take on more credit risk has been seriously affected. The share of FHA-insured single family mortgages was under 2% in 2006 but has risen exponentially reaching close to 19% in 2009. It is expected to consider increasing in 2010.

The FHA counts on the federal government for funding and it looks like the current funds will run out in 2011 (check out www.HUD.org for more information). The FHA will have to ask for more funding sometime in mid 2011, maybe even before that if the market share continues to increase. During these difficult times, many other agencies/entities including FNMA are posing to ask for or currently counting on the government for bailout in the current economic climate, and so funding for FHA may run into some hurdles. Why is this important? It is but one factor for boards to consider in determining whether and who to use to seek FHA certification in the coming year.

At the same time many are suggesting that FHA will be the best source of funds for individual (non investor) loans in the near future, the FHA has taken steps to initiate its own protections against defaulting loans.

It is no longer accepting “spot certifications” in a condo association for one loan by one lender. The certification process for FHA loans in the past was accomplished on a “spot” basis by completion of a lender questionnaire and underwriting “machinations” between the lender and the FHA. This process was not perfect as completion of these questionnaires was problematic for HOAs and managers, largely for two reasons. One was the considerable liability potential and the other was concern over the creation of an additional legal relationship that did not otherwise exist (between the HOA and the buyer/lender/and other parties involved in the sales transaction). Still, completion of the questionnaires and spot certification did commonly get done one way or another. People found a way to get over the hurdles.

Now, there are additional hurdles. The FHA has added/increased restrictions for the criteria for condo loans. The requirements now include a 15% limit on delinquencies. This in and of itself is very difficult to achieve in these times. And the FHA says it will not consider developments with more than 20% commercial space or where any one person or entity has ownership of 10% or more of the condos in the development. Last but not least, lenders must attest to the “adequacy” of finances in the condo association. This attestation is accomplished through a special form provided by the FHA. In some cases, a current reserve study might suffice as long as it is not more than one year old. The form has a number of pointed questions and if the information on the form turns out to be false and the discovery comes through a loss to the FHA, the agency might be looking to recover the losses and any of the following might become a target: the lender, HOA manager, and/or the condo association or whomever provided false, misleading, unrealistic or inadequate information that lead to the loss.

And, without the “spot certification” process as an option, in order for buyers to qualify for FHA funding of any individual unit within a condo association, the entire association has to be “project certified.” This is a more complicated (time consuming and costly) process than the spot certifications previously accepted. Attestations have to be made. Forms have to be filled out. Governing documents have to be reviewed. And although the FHA does not require it, many lenders are also requiring attorney certification letters.

Among the questions and concerns are:

Who is going to seek the certification?
Will the manager want to do it?
What is it going to cost?
Who is going to pay those costs?
Will a Condo Board be obligated to seek certification?
Can it be sued for not doing it?
Can an interested buyer (or investor wanting to buy units) seek to get the entire development certified?
Who will accept the liability for mistakes in certifying information?

As for the question about whether a condo association should pay the fees to seek certification, the basics for charging fees to anyone are this: there has to be some underlying authority to charge any fee to an owner. Seeking development-wide certification may result in considerable costs (I am hearing $1500 to $5000 as estimates). So the question becomes, who should pay for the HOA certification process? Would it be all owners in the development (making this a budget item) or just those who need the benefit of it? And, another rub Š the certification is not forever it lasts for two years. However, there is some good news. If an association is certified and the certification expires, recertification should be a much easier and less expensive process.

Civil Code Section 1366.1 provides limitations on what an association can assess or charge an owner: That law says:

“1366.1. An association shall not impose or collect an assessment or fee that exceeds the amount necessary to defray the costs for which it is levied.”

Some feel this might be a limit on charging each owner a portion of the certification fee as that is not normally a budget item; others seem to believe the statute does not apply because the board is seeking a service that it believes is in the best interest of the members.

Another limitation applies when charging any sum as a “transfer” fee. HOAs and condo associations are limited by Civil Code Section 1368 which lists the items a seller has to provide to a potential buyer (although the seller can ask the association to provide the documents), as follows:

“The association may charge a reasonable fee for this service, based upon the association’s actual cost to procure, prepare and reproduce the requested items.”

None of the information or documents listed in Civil Code Section 1368 includes the FHA Certification, nor is any owner/seller required to provide it, so charging any seller/owner a share of the cost to get it does not seem to be justified by this statute.

For managers out there – if the manager offers their services to apply for the certification the question arises as to whether the manager can find a way to be reimbursed for the service, and also whether whatever income that can be derived from it worth the liability risks. Will the managers expect the association to pay? Will buyers who seek FHA loans in the development be called upon to pay a fee? Again, if there is an attempt to call any fee assessed a “transfer fee”, could present a problem. And one can be sure that people will argue over the authority to charge, and the responsibility for the costs aspect.

If a management company or manager gets involved and does the work, it is important to be insured. Many managers rely on the indemnification clauses in their contracts with the association for protection and it makes some sense if the manager is seeking approval on behalf of the association to have this kind of protection. However, it a manager is seeking approvals for associations as a business, including associations it does not manage, the question arises as to whether the association should bear the responsibility for what the manager says in the paperwork or in working with the FHA representatives. The association is providing the underlying information but the manager will be answering questions that I believe go further than the figures provided. Without any day to day involvement, a manager, or for that matter for any company that does the certifications, it is difficult to assess whether the finances are “adequate”.

In any case, the question arises as to whether the market will bear the costs sufficient to pay for any E and O coverage required for protection in doing this kind of work. And there may be other legal questions that need answering. One manager sent questions to my blog as follows:

if the manager does the work to get a condo development certified, can he or she charge the costs to the owners who are getting FHA loans? Is it a RESPA (Real Estate Settlement Practices Act) issue?”

The fact is that this Act also presents another area of possible complication in making disclosures. Under it, a new “Good Faith” Settlement Statement (HUD-1 form) is required and already questions have arisen as to what association costs have to be included in this form (hint, think transfer-related costs in a sale situation). Thus, as of this writing, answers to these questions about what laws might apply to managers who take on seeking project certification have not yet been fully vetted, but they will be in the coming months.

It is important to know that there are entities other than managers/management companies that offer services to assist with certification. HomeWiseDocs.com is one. Another company is called FHA Pros (www.CheckFHAapproval.com). I am sure there are more, and even more may crop up in the coming years. And there are lenders willing to help Condo associations seek certification in some geographic areas and I am assuming that when a lender rep is working with the HOA to get the certification, the carrot at the end of the stick is that the lenders would hope to benefit from the condo association certification by considering loans in the complex. One thing to note of course is that the certification does not guarantee that loans will be made. There is much more criteria involved on the buyer qualification side of things.

The plot thickens on issues of condo and other homeowner association properties. The subprime mortgage fiasco continues in its domino effect. The toll taken includes serious limits on available money for condos and other properties in homeowners associations. This is wreaking havoc in more ways than one.

With financing options getting more and more limited, and prices dropping like flies, investors are swooping in and picking up the pieces. That might be a good thing if it revives an HOA having trouble collecting assessments from owners who walk away from their obligations to pay assessments or go through a bank foreclosure causing the write off of assessments. It an also be a bad situation if an investor ends up owning 10% of the units (which would be as few as 2 units in a 20 unit association) or owns enough units to usurp control, or fails to pay assessments on multiple units.

There are those that will argue vehemently that condo associations must seek FHA certification, and those that will argue otherwise, claiming it is not cost effective or necessary. Stay tuned. This article is offered for informational purposes. You will hear a lot more on the issues of homeowner association financing options and questions in the coming months. Associations will have to decide what to do about seeking FHA certification.