Buying a condominium using a mortgage involves a more stringent set of lending criteria than when you buy a stand-alone home. While it is not difficult to obtain a condo mortgage, it pays to understand the mortgage requirements upfront so that you don’t have any nasty surprises. It also will impact you when it comes time to sell your condo, so that you understand the loan situation for prospective buyers.
Before I get into the checklist, I do need to remind you that lending standards do vary over time. In a booming market, lending guidelines are loosened (too much so in the previous housing boom) and currently have become far more stringent. The only reliable way to understand the current guidelines is to speak with a mortgage loan officer who is familiar with the current guidelines.
Mortgage Considerations for Condos
- Is the condo FHA approved? – FHA loans are frequently being used right now by borrowers with less down payment money available. (Currently you can get an FHA loan with as little as 3.5% down.) In today’s market, anywhere from 20%-50% of condo buyers may be using FHA loans, particularly at lower price points. In order to obtain an FHA loan on a condo, the entire condo complex must be FHA approved. That is a multi-month process and is critical for condo marketability at the moment. Even if you don’t need to use an FHA loan to buy, purchasing in a complex that is FHA approved does make it easier when it comes time to sell, as you have a larger market of potential buyers.
- Does the building have a rental limit? – Rental limits are common, but not universal, in condo complexes. From a condo owner perspective, having no limit on rentals gives you maximum flexibility if you decide to move out and rent your place, but it can have severe consequences on the ability to resell units in the complex. Banks see a building that is primarily owner-occupied as a lower risk and will only offer condo mortgages on buildings that are occupied by a majority of owners. For conventional loans the current limit is typically 70% owners/30% renters. FHA loans are more generous, offering loans for buildings that have 50% owners/50% renters. If a building exceeds this limits, buyers cannot obtain mortgages and you are forced to sell to buyers who have all cash, severely lowering your market value. As a side note, if you intend to buy a condo and rent it, make sure that the complex is within its rental cap, otherwise your ability to rent the unit will be put on a waiting list.
- Pending or active litigation – Recently built condos may have construction defects that need addressing. Frequently condos will pursue the condo builder with a lawsuit to try to get them to fix construction defects or recoup costs involved with the fixes. Condos that are in active litigation will not be able to obtain new mortgages until the litigation is complete, which can take a couple of years. Pending litigation presents the same problem if the Homeowners Association (HOA) documents indicate that a lawsuit is imminent. There is a grey area where condos are considering litigation or negotiating with the builder prior to litigation where loans may still be possible, but the moment litigation ensues, you can only buy units in the complex with all cash.
- Special assessments – Condos that do not have enough money in reserves to pay for large repairs will be forced to issue a special assessment to each unit owner. This could be as small as a couple thousand dollars, or as large as $100k or more. Buying a condo that has an active special assessment is not an automatic cause for alarm, provided that you can negotiate a suitable agreement with the seller to pay for some or all of the assessment. Condo lenders will want to see that the special assessment has been paid prior to issuing their loan. You also want to evaluate if the special assessment has plunged a large number of unit owners into default, which leads to other problems.
- Too many units in default – Condo lenders do have guidelines about the maximum number of owners who can be in default on their HOA dues. Too many people late on their HOA payments means too much risk to the lender, and they will not make loans on the building. You need to review HOA documentation to determine the current status of HOA payments to watch out for this one.
- Reserve study & underfunded HOA reserves – Many condos have a reserve study conducted every few years. The purpose of the study is to evaluate the lifespan of all systems in the building and estimate the cost and timetable for their replacement or repair. Banks making a loan on condos want to see that the HOA has an adequate reserve balance in anticipation of future repairs, and they also want to see that monthly reserve contributions are being made to maintain or increase that balance. FHA wants to see 60% reserve funding, and conventional loans typically want to see a current reserve study and at least 10% of the annual budget being placed in reserve for future repairs.
As a condo buyer, it pays to understand the current lender requirements for condos. You want to buy into a condo complex that enables you to freely get mortgages, even if you don’t need one, and you also want to make sure that you won’t buy into a complex that is going to be a problem to resell in the future. Availability of mortgages for a particular building is key to maintaining market values. Cash buyers are few and far between and will demand a steep discount if they know you can’t get any other buyers.