A legal look at why condos are harder to finance by Richard D. Vetstein.
Since the condominium market meltdown, both Fannie Mae and FHA have passed increasingly stricter and tighter lending guidelines on condominium financing. Of particular concern to the agencies and potential buyers is the capital reserve account. For those who don’t know, a condominium capital reserve account is an emergency fund set aside for major capital common area repairs and expenses, such as a leaky roof, a new boiler system, or other major structural issues. In a new condominium, the developer will establish a capital reserve account through mandatory contributions by new buyers, then a certain percentage will be allocated towards that capital reserve account every month through condo fees. In established condominiums, some have already set up a healthy capital reserve fund, while others have little, if any, money set aside. That’s where the problem starts as far as Fannie Mae and FHA are concerned. 10 percent of operating budget now the goal.
FHA is now the strictest lending program for condominiums. Ironically, FHA is typically the loan of choice for first time condo buyers. FHA rules now require that condominiums set aside at least 10 percent of their operating income towards their capital reserve accounts. So if the annual budget is for $200,000, then $20,000 must be set aside in the capital reserve fund.
The lender may also require a review of the annual budget, and where the budget is inadequate, require a capital reserve study.
With regard to Fannie Mae, the 10 percent rule is often required by lenders although it’s not technically part of the Fannie Mae condominium guidelines. However, arguing with Fannie Mae and lenders about this issue is tough because a healthy capital reserve account is critical for the financial stability of any condominium project, and hence, vital to the underwriting of the condo mortgage loan.
Accordingly, for all FHA and some FNMA loans (the vast majority of conventional loans), the 10 percent capital reserve account rule will come into play.
What if my condo doesn’t have 10 percent in reserve? Well, you will have a problem selling your unit, and you may have unintentionally picked a fight with the condo trustees. The Massachusetts Condominium Act requires the establishment of an “adequate” capital reserve account but does not specify how much money needs to be in it. Arguably, 10 percent of operating budget is now “adequate” under the law, but there is no court precedent yet.
I will say this. Condominium trustees, boards and managers who do not keep the condominium’s finances in compliance with current Fannie Mae/FHA secondary mortgage lending requirements run the risk of violating their fiduciary duties towards unit owners. If unit owners are hindered in selling their units to buyers seeking FHA/Fannie Mae loans because capital reserve accounts are insufficient, that’s a huge problem.
Bottom line, I would advise all Massachusetts condominiums to get their capital reserve accounts beefed up to the 10 percent mark. It’s a win-win for everyone.
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