For those of us who have worked in the mortgage industry long enough to become comfortable and familiar with all the jargon and acronyms, it can be hard to remember what it was like to feel overwhelmed and uncertain about the mortgage process. We are modern-day alchemists who can turn a 1003 and some pay stubs into a new home for a family. The knowledge and processes we utilize to do so can seem just as arcane and occult to our borrowers as the rituals of ancient alchemists must have seemed to a simple farmer. Yet, within this society of secret knowledge, exists a field of expertise that confounds and intimidates even the most seasoned mortgage professionals. Senior underwriters break out into nervous sweats. Experienced processors develop headaches and need to get another cup of coffee. This labyrinth of doubt and confusion is Project Review, specifically condominium and cooperative property types. We hope we can provide some insight on how to review a condominium project.
We are modern-day alchemists who can turn a 1003 and some pay stubs into a new home for a family.
Step One: Limited or Full Review?
One of the most confusing aspects of reviewing a condominium is trying to determine which review type is required for your subject loan. The Fannie Mae Selling Guide lists several different review types for condos, but the most common are Limited Review and Full Review. What makes a loan eligible for a limited review type? Whether a limited review can be performed is dependent on the parameters of the individual loan, not the project itself. The logic behind a limited review is that the loan itself is a low enough risk that the review of the project does not need to be as rigorous.
The three parameters that determine whether a loan is eligible for limited review are:
For properties in all states, except Florida, the maximum LTV/CLTV for each occupancy type is:
- Owner Occupied – 90% LTV/CLTV
- 2nd Home – 75% LTV/CLTV
- Investment – 75% LTV/CLTV
For properties located in Florida, the maximum LTV/CLTV for each occupancy type is:
- Owner Occupied – 75% LTV/90% CLTV
- 2nd Home – 70% LTV/75% CLTV
- Investment – 70% LTV/75% CLTV
New or Established?
Keep in mind that if a project is “New Construction”, it is not eligible for a limited review. It will require a full review, regardless of the specific loan parameters. So, how do you know if your condo is considered “New” or “Established”? Recent guideline updates have made this more complicated, but also give you more wiggle room to make your project work.
In order to be considered “Established”, the following must be true:
- The project must be 100% complete, including all units and common elements
- The project may not be subject to additional phasing or annexation
- Control of the HOA must have been turned over to the unit owners
- At least 90% of the total units in the project have been conveyed (sold or under contract) to unit purchasers…
But here is where the wiggle room comes in…
- A project can also be considered “Established” with less than 90% of the units sold to unit purchasers, as long as the unsold units are being retained by the developer as rental units.
However, if you are going to use this definition of “Established”, then along with the first three items above (100% complete, no additional phasing, control of HOA turned over), the following must also be true:
- The developer’s rental units must equal less than 20% of the total units in the project
- All HOA fees must be paid current in developer-held units
- There may not be any active or pending special assessments in the project
Now that we know what TYPE of review we need (limited or full), we can move on to the next step.
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Step Two: Review The Questionnaire
The condo questionnaire is your primary review document. It can be filled out by a representative of the homeowner’s association, the property management company, or another party that is familiar enough with the project to answer the questions accurately. The one person who may not complete the questionnaire is the borrower.
Generally, lenders will have their own standard questionnaire form that they send out to be completed and returned. Fannie Mae has their own versions that can be used if you don’t have access to your own form.
The FNMA long form can be found here: https://www.fanniemae.com/content/guide_form/1076.pdf
The FNMA short form can be found here: https://www.fanniemae.com/content/guide_form/1077.pdf
The questionnaire gives us information about the project, such as number of units, and monthly dues payments, but its primary function is to determine whether the project has any characteristics that would make it ineligible for lending according to Fannie Mae.
What makes a project ineligible?
Fannie Mae has a very long list of things that can disqualify a condo project from eligibility. Something to bear in mind is that unlike a single family residence, a property located in a condominium project may be declined for reasons that have nothing to do with the subject unit being financed. Here are some of the most common examples of ineligible characteristics:
- Projects with mandatory upfront or periodic membership fees for the use of recreational amenities, such as country club facilities and golf courses, owned by an outside party (including the developer or builder)
- Projects that are managed and operated as a hotel or motel, even though the units are individually owned
- Projects with non-incidental business operations owned or operated by the HOA including, but not limited to, a restaurant, spa, or health club
- Projects in which the HOA is named as a party to pending litigation, or for which the project sponsor or developer is named as a party to pending litigation that relates to the safety, structural soundness, habitability, or functional use of the project
- Projects in which a single entity (the same individual, investor group, partnership, or corporation) owns more than the following total number of units in the project:
- Projects with 5-20 units – 2 units
- Projects with 21 or more units – 20% of the total units
- The total space that is used for nonresidential or commercial purposes may not exceed 35%
Step 3: Project Document Review
We have finally reached the last step, we know the review type and if the subject is new or established. From here we need to finish up looking at these key components of the process.
Despite the long list of potentially ineligible features that can come up when reviewing a questionnaire, one of the most common reasons a condo has to be declined is an unacceptable budget. The problem with condominium budgets is what you end up getting from the HOA is so wildly unpredictable. You may receive a professional, clearly labeled budget from a property management company that shows all income and expenses, including the required reserve transfers. Those are the best! Or you may receive the retiree-HOA-president’s best guess about what they might spend for the next year hand-written in illegible cursive with no accounting for predicted income or transfers to a reserve account. Sometimes it feels as though the person creating the “budget” doesn’t even know what a budget actually is
Even if the budget is well done and easy to read, the reserve requirement may fall short. Fannie Mae requires all full reviews to include a budget with at least 10% of the annual maintenance income set aside into the reserve account. There are some work-arounds that can be used to get the percentage up a little higher if they are a bit short, but if the loan needs a full review, the budget can be a hard stop. Some HOA’s have such a large balance in their reserve account already they don’t think they need to contribute a full 10%. Fannie Mae doesn’t care. A $1 billion reserve account balance wouldn’t overturn the 10% budget requirement. The only exception to the 10% rule is if the HOA has a current (completed within the past 3 years) reserve study, performed by an outside company, showing their current reserve contribution is sufficient.
All condo reviews, limited and full, include some sort of insurance requirement. The insurance piece is, by far, the biggest source of declined projects (and headaches!). Understanding and interpreting insurance industry jargon is enough to make your head spin without trying to verify that the policies meet Fannie Mae guidelines. Below is an overview of each required policy type and some information on what makes it acceptable.
Master Property Policy
Every property policy, regardless of review type, must include the following:
- 100% replacement cost coverage
- Coverage for wind damage
- Present in Special or Broad form coverage
- Building Ordinance & Law endorsement
- Required on all policies where it is available from the insurance company
- Equipment Breakdown endorsement
- Required for projects with large, expensive, central boilers or HVAC systems
Some red flags to watch out for on a master property policy are:
- Costs the HOA a penalty fee if they are under-insured during a loss event
- Pooled Policies
- Giant policy coverage amount split between several unaffiliated HOAs
General Liability Policy
Liability coverage is only required for full reviews, and it must have a coverage amount of at least $1 million per occurrence. The only tricky thing about the liability policy is that Fannie Mae requires you to confirm that the policy includes “Separation of Insureds”. This is standard wording in most general liability policy forms, so you may run into someone at an insurance agency who doesn’t know what you’re asking for and gets confused looking for a separate endorsement on the policy. I’ve found the easiest way to confirm its presence in the policy is to ask: “Does the general liability form include the separation of insureds language?”
This policy can go by several names: Fidelity, Crime, Employee Dishonesty, but they all mean the same thing. Fidelity coverage is another policy that is only required for full reviews, and even then, only for projects with more than 20 units. The coverage amount required is dependent on whether or not the HOA/Management company has some specific financial controls in place:
- Separate bank accounts are maintained for the working account and the reserve account, and the bank in which funds are deposited sends copies of the monthly bank statements directly to the HOA
- The management company maintains separate records and bank accounts for each HOA that uses its services
- The management company does not have the authority to draw checks on, or transfer funds from, the reserve account of the HOA
- Two members of the Board of Directors must sign any checks written on the reserve account
As long as at least one of these controls are in place, the minimum fidelity coverage amount required is equal to three months of total assessments for the project. Otherwise, the fidelity policy must cover the total of all cash on hand for the HOA (operating and reserve accounts). If the HOA is managed by a property management company, that company must be covered by the policy, either through a Managing Agent Rider or as an Additional Named Insured.
Flood insurance is only required if the condo is located in a flood zone, and then we only need to see coverage for the building in which our subject unit is located. The amount of flood coverage required is the lesser of:
- 80% of the replacement cost shown on the RCBAP
- The maximum insurance available from the NFIP (which is $250,000 per unit in the building)
Project Legal Documents
So, what if your condo is new construction? What else do you need to review in that case? Fannie Mae requires a review of the project’s legal documents or Covenants, Conditions & Restrictions (CC&Rs). This document can be a bit confusing if you’re not used to reading legalese, but there is a list of specific items you need to find in order to satisfy Fannie Mae.
- Right of First Refusal – Not every project will have a Right of First Refusal so that’s the first thing to check in the documents. If it isn’t mentioned, great! Move on to the next step. If the project does retain the Right of First Refusal, you will need to verify that it will not adversely impact the rights of a mortgagee or its assignee to:
- Foreclose or take title to a condo unit pursuant to the remedies in the mortgage
- Accept a deed or assignment in lieu of foreclosure in the event of default by mortgagor
- Sell or lease a unit acquired by the mortgagee or its assignee
- Rights of Mortgagees to Written Notice – The mortgagee must have the right to timely written notice of:
- Any condemnation or casualty loss that affects either a material portion of the project or the unit securing its mortgage
- Any 60-day delinquency in the payment of assessments or charges owed by the owner of any unit on which it holds the mortgage
- A lapse, cancellation, or material modification of any insurance policy maintained by the homeowners’ association
- Any proposed action that requires the consent of a specified percentage of mortgagees
- Mortgagee’s Rights Confirmed – The legal documents may not give any party priority over the rights of the first mortgagee of the unit in the case of payment of insurance proceeds or condemnation awards for losses to the unit
- Amendments to Documents – The project documents must include provisions for the following:
- Amendments of a material adverse nature to mortgagees be agreed to by mortgagees that represent at least 51% of the votes of unit estates that are subject to mortgages
- Any action to terminate the legal status of the project after substantial destruction or condemnation occurs or for other reasons to be agreed to by mortgagees that represent at least 51% of the votes of the unit estates that are subject to mortgages
- Implied approval may be assumed when a mortgagee fails to submit a response to any written proposal for an amendment within 60 days after it receives proper notice of the proposal, provided the notice was delivered by certified or registered mail, with a return receipt requested.
Reviewing a condominium is, admittedly, a complicated process. There are lots of moving parts and plenty that can go wrong, but it can be mastered. Hopefully we’ve helped provide some insight and some step by step direction on what goes into a condo review and made the process a bit less scary.
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In this blog we introduced you to two of our newest team members: Lisa Geloso and Crystal Pickering. With combined experience of over 30 years in the mortgage business, and a focus on project reviews, they have knowledge and skills necessary to teach you the perfect system of condo and coop project reviews. If they can’t get you to the land of “eligible projects” then no one can!