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Rules Governing Loans for Condos, Co-ops, and Townhouses

Although Fannie Mae and FHA have specific guidelines that lenders use to approve a buyer, these agencies also have certain distinctions between the various stages a condominium or townhouse might be in.

Condos can come in all shapes and sizes and can be as few as two units or a city skyscraper 50 stories high with hundreds of units. They can be built new or they can be converted from a previous structure such as an old apartment or office building.

Because condos can vary so much, Fannie Mae and FHA have rules that govern which types of condos loans can be made on and which ones cannot. Some condos can't qualify for conventional or government financing because the project doesn't have certain characteristics, such as a predominance of owner-occupants compared to units that are rented out.

Or there may be too much commercial activity or perhaps if s a condotel. But just as Fannie, Freddie, VA, and FHA have guidelines for buyers, they have strict guidelines for the project itself.

Fannie and Freddie, which set conventional guidelines, classify condos using “types” for Freddie and “classes” for Fannie. Each designation lets lenders know how to set about approving the condominium project so that the loans they issue are legitimate under conventional guidelines.

Fannie Mae and Freddie Mac used to approve condominium projects themselves using information provided to them by an individual lender or by a developer wishing to get Fannie Mae and Freddie Mac approval. When a condo project has approval from conventional or government guidelines, then the units retain their value because financing will be widely available through most mortgage lenders.

There are also two types of reviews: A limited review is when the lender answers a set of basic questions regarding the condo project; a full review is when the project undergoes a thorough examination of the building's history, engineering reports on the structure, evidence of legal transfer of ownership from the developer to the HOA, and so on. If a project does not have a prior approval from Fannie, Freddie, VA, or FHA, it may take too long to get approval in time to meet the contract date.

What is required in a full review? It's a lot, and it's why developers are supposed to get their project approved at the early stages of development. Sometimes they don't. And when that happens, unless the project is designated as a limited review project, it's not likely you'll get conventional or government financing.

Here is what is required in a full review

Appraisal. The developer must show the current value of the unit and also show that the unit meets certain guidelines, such as all units having separate meters for electricity and other utilities.

Minimum Insurance Coverage. Condominium projects must have a minimum amount of insurance — not only to protect the structure itself, but also to protect the association from lawsuits. Most liability coverage requires at minimum $1 million in protection plus structural and common area protection. An insurance policy must include 100 percent replacement riders as well.

Legal. Legal documents that conform to current guidelines must be reviewed by an attorney to certify that the project meets conventional and government guidelines.

HOA. Lender will warrant that the HOA budget is adequate to cover reserves for replacement and maintenance of common areas such as sidewalks or swimming pools and have at least a 10 percent reserve set aside for deferred maintenance. Deferred maintenance items are those that need to be repaired to keep the value of the condo intact such as roofing, paint, windows, and such.

Occupancy. At least 51 percent of the units must be owner-occupied or listed as vacation units (versus rental units).

Single Entity. The lender must determine that no individual can own more than 10 percent of the units in the project. This is done by surveying ownership of the individual units or through verification from the HOA.

Delinquency. No more than 15 percent of the units can be more than 30 days past due on their HOA dues.

Utility. No more than 20 percent of the square footage of the project can be for nonresidential purposes.

Is that a mouthful, or what? Now let's add additional requirements for co-ops.

Marketability. The project must be located in an area where there are other co-ops.

Completion. The project cannot be subject to additional phases.

Occupancy. Owner-occupancy requirements increase from 51 percent to 80 percent.

Ownership. No individual may own more than 10 percent of the stock or shares of the cooperative.

Facilities. Amenities such as parking or workout facilities must be owned by the co-op.

Commercial. Any commercial spaces must be compatible with the surrounding project and market, and any income to the co-op cannot exceed 20 percent of its total income.

Financials. It must be shown that the co-ops budget is such that it is able to meet current and future operating expenses.

Management. It must be shown that there is an adequate management team in place. Professional management companies manage most co-ops. If this is the case, the contract with the management company can't have a prepayment penalty if the contract is cancelled.

Is this enough? Full reviews are onerous, and if the project you're thinking of buying doesn't already have a conventional or government approval, then you're going to have your work cut out for you. This list takes some time, effort, and resources to get a project approved.

A limited review is much less invasive and can be performed in a relatively short time, as the lender goes down a simplified list of questions. This questionnaire is sent to the HOA for it to complete. A typical questionnaire asks for the following information:

1. What is the total number of units in project?

2. What is the total number of units sold or under contract?

3. What is the total number of units rented?

4. How many phases are there?

5. Is subject phase complete?

6. Are all the common areas complete?

7. Does any single entity own more than 10 percent of the units?

8. Is there a lobby with a rental desk?

9. Are short-term rentals allowed?

10. Are there time-share arrangements?

11. Is the HOA involved in any litigation?

12. What percentage of owners are more than 30 days delinquent on HOA dues?

The HOA would answer these questions and return the form to the lender, who would review the answers to make sure they comply with condo guidelines. The lender would then examine the insurance policy to make sure that the property is properly covered. With a limited review, the condo or town- house project isn't universally approved, meaning anyone who wishes to finance a unit in the project won't have to go through the project-approval process. The lender will place a loan for that individual purchase. Limited reviews typically requite a minimum of 20 percent down.

This method of approval is sometimes called a “spof approval. It is used when Fannie, Freddie, VA, or FHA hasn't yet approved the property.

Finally, there is an expedited approval process using Fannie's online project approval method (Condo Project Manager, or CPM). This is an online process of approving condos that provides lender-specific project acceptance.

Property classes and types are important because it may mean you have to put more down. It may also mean that you can't get conventional approval at all. Co-ops, in particular, have only one review process — the full review — if you want to get conventional financing. If the co-op doesn't meet Fannie guidelines, then conventional financing won't work and you must go with a portfolio lender.

Because Freddie Mac, FHA, and the VA do not offer financing for co-ops, Fannie is the only conventional source of funds for these properties.

Fannie Mae offers the following condo types:

Type P Limited Review for New Project

Type Q Established Project or Established Two- to Four-Unit Project

Type R CPM Expedited Review or Lender Full-Review New Project

Type S CPM Expedited Review or Lender Full-Review Established Project

Type U FHA-Approved Project

Freddie Mac, the other conventional loan type, used to categorize condos by classes but now simplifies condo types into the following two types: established and new construction.

Established condominiums require that ownership of the condos be transferred to the HOA from the developer and meet the same general guidelines as Fannie types. New construction also follows similar guidelines as Fannie Mae.

In fact, Fannie, Freddie, and FHA can have reciprocal approvals where one agency will automatically approve a project that was previously approved by the other two.

There's an exception: projects using VA financing (because the VA still approves condo projects independent of any lender). And remember, neither FHA, VA, nor Freddie Mac makes allowances for co-ops.

For years, classifying condominiums was a real burden. Sometimes developers wouldn't go through the tedious process of getting their project approved and would leave it up to the buyers to get their own financing. Or they might arrange financing with a local bank or lender. But gradually the condo approval process eased, making buying and financing a condo much easier.

If the project does receive approval, it is deemed “warrantable,” meaning that the lender warrants that the project meets condo guidelines. If the project does not meet condo guidelines, the condo is then labeled as “unwarrantable.”

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