United States: "How The New FHA Regulations Will Affect Your Condominium"

This article originally appeared in the CCOC Communicator and is reproduced by permission.

When the Federal Housing Administration ("FHA") began insuring loans made by private lenders, it allowed lower-income and first-time purchasers who had less money to put down, who were otherwise credit worthy, to obtain a home loan. Over the years, FHA backed loans have become increasingly more popular. In 2007, FHA backed only 5% of condo mortgages, but that percentage jumped to over 20% in 2009, with no signs of slowing. Many believe, in fact, that FHA backed loans will become the dominant avenue for mortgage lending. These skyrocketing numbers have occurred for several reasons. First, FHA's increased maximum values for loans (currently over $700k in the Washington, DC metro area), low interest rates and smaller down payments make these loans attractive to purchasers of all types. In addition, the collapse of the housing market has made FHA insured loans more attractive to private mortgage companies. Unfortunately, the housing market collapse, together with the increased popularity of these loans has forced HUD to adopt new, more stringent requirements for FHA backed loans for condominium units. In fact, after this article was written but before it was published, additional regulations have been adopted by HUD which will take effect on August 30, 2011. Clearly, these restrictions remain a "moving target" and condominium associations should be cognizant that they continue to evolve.

Previously, when someone purchased a condominium unit and wanted to obtain an FHA backed mortgage, the purchaser could obtain approval of the condominium association where the unit was located for that specific loan by providing some basic information regarding the condominium association. These types of loans were called "spot loans" because FHA approved the condominium association for only that specific loan. While this process benefitted condominium associations by putting the burden on the purchaser to obtain approval, FHA lacked a lot of information about the financial health of the condominium association where the unit was located, so over time, FHA developed concerns that defaults in some FHA backed loans was due, in part, to the poor financial health and overall condition of the condominium association where the property was located. In fact, some condominium associations were essentially inoperative, resulting in no maintenance of the property and devaluing of the units – a risky combination for a home loan.

In November 2009, FHA abolished "spot loans" altogether and decreed that FHA backed loans would be permitted for purchases of units located in condominium associations that were approved by FHA after going through an intensive application process. The application process includes submitting, among other documents, copies of the association's governing documents, budget, meeting minutes, proof of insurance and where the property is located on a FEMA flood map. All condominium associations, including ones that were previously approved by FHA, had to undergo the re-approval process. Notably, applications will be accepted only if submitted by the condominium association or its agent -- potential purchasers, current owners and realtors cannot submit an application on behalf of the condominium association and if they do, they will be rejected outright. According, boards have to evaluate whether they should undertake this process to get the association approved.

As a threshold matter, a board has to determine whether it would be a violation of its fiduciary duty to the association's membership to not proceed with this application process. For many associations, being approved for FHA backed mortgages could broaden the pool of potential purchasers, which would be helpful to the members trying to sell their units in this still unstable housing market. However, the expense of going through the process may not be within the association's budget and frankly, condominium associations which have a lot of foreclosures would potentially not even qualify for approval, making the process would futile. Accordingly, the first step in evaluating whether an association should undertake this process is to review whether the association can meet the minimum requirements for approval.

One of the requirements that some condominium associations are having a difficult time meeting is that no more than 15% of the total units in the association may be more than 30 days delinquent in the payment of assessments. Notably, recent changes in regulations have clarified that this applies only to assessments and not to late fees, fines or any other charges on an owner's account. While boards of directors are working hard to collect outstanding assessments, most condominium associations have a higher number of bank owned properties than they have had in the past. Banks tend to not pay the assessments which come due after they have foreclosed until the property is sold to a third party. Since FHA does not carve out an exception for bank owned properties, these non-paying bank owned properties alone may make it impossible for a condominium association to qualify. Ironically, the banks are practically guaranteed to pay the past due assessments, plus interest when they sell the units, but FHA is using their current state of nonpayment against associations. If anything, these bank owned properties should reassure FHA that these units will ultimately be current. Fortunately it is our understanding that HUD is aware that these bank owned properties are having an unfair negative impact on the ability of associations to qualify for FHA backed loans, so hopefully there will be an exception created for these properties in the future.

Since the impetus for these changes for FHA approval is to have reassurance that the condominium association is in good financial health, FHA is scrutinizing special assessments. FHA is requiring associations to submit detailed information showing how the special assessment was adopted and the purpose for it. Fortunately, it appears that FHA is approving associations with special assessments to make up for budget shortfalls, including the massive snow removal bills in the 2009-2010 winter season. But, based on the scrutiny of the special assessments, it is clear that FHA may deny approval for a condominium association if there are special assessments imposed for other reasons, like litigation costs or defects in buildings, or exorbitant ones to be paid in short periods of time. Regrettably, special assessments are imposed to improve a condominium association's financial health, yet they may ultimately result in the denial of the association's application.

Another restriction that is problematic for associations is that the reserve balance and the budget for the association must be "adequate." FHA requires that at least 10% of the budget be earmarked for reserves and the total reserve balance must be sufficient based on the age of the community and common elements. After August 30, 2011, applications must include balance and income sheets that are less than 90 days old in order for FHA to review the association's finances. If FHA denies the application for failing to meet this requirement, the condominium association may need to obtain a reserve study and/or submit additional documentation supporting an argument that the budget and reserve balance are sufficient. While this sounds like a headache, it does have the benefit of a third party reviewing the budget and current reserve balance and giving the condominium association feedback as to whether it is sufficient. Many boards leave the budgeting process largely to a manager, as opposed to taking an active role in the process and this second guessing by FHA may be the trigger to get the board members more actively involved in the process.

FHA requires that condominium associations with at least 20 units have fidelity insurance or a fidelity bond for all officers, directors, and employees of the association and all other persons handling or responsible for funds administered by the association. The coverage must be no less than a sum equal to three months aggregate assessments on all units plus the current balance of reserve funds. Notably, the aggregate assessments include special assessments, so associations are required to have insurance at higher amounts where there is a special assessment in place. Fortunately, this requirement has forced condominium associations to review their insurance coverage and many associations find that they in fact, are underinsured, which is better discovered now, as opposed to when they have a theft or other similar loss. Beginning on August 30, 2011, if the association contracts with a professional management company, that company must also have fidelity coverage, so applications will need to include a copy of the management company's certificate of insurance as well. In addition, associations will have to show that they have hazard insurance which is "blanket" and covers 100% replacement cost.

Once a condominium association receives approval under this new process, the approval lasts for three (3) years, so associations will need to go through a re-approval again after that period expires. In addition, it appears that FHA is also incorporating some requirements for an ongoing certification requirement whereby changes to eligibility of the association (i.e. lawsuits against association, special assessments) would have to be disclosed during the three-year period with steep sanctions for noncompliance. FHA is optimistic that the re-approval process at the end of the three year period will be streamlined since FHA will have all of the basic information for approved condominium associations after going through this initial process. In fact, FHA is hoping that at some point the condominium association applications and supporting documentation would be maintained electronically, so renewals would simply be a matter of updating certain information without the requirement of submitting unchanged documents, like the recorded covenants.

So, if a condominium association can meet all of the requirements to obtain approval, the board must then decide whether to proceed with the application process and there are an infinite number of factors that the board needs to take into consideration. Condominium associations with units that sell for amounts far above the maximum loan amount for FHA backed loans would likely not affect potential purchasers at all by not obtaining approval. In addition, once a condominium association receives approval for FHA backed mortgages, there is no guarantee that other entities, like Fannie Mae and Freddie Mac will approve a loan to purchase a condominium unit in that same association. In fact, there are instances where the condominium association was approved by FHA pursuant to this new procedure, but purchasers were unable to obtain lending from these other entities. A board also needs to consider whether the budget will support the expense of the application process – which is accomplished much more efficiently, but at significant expense -- if handled by an attorney or a company that handles these types of applications. In short, it is not necessarily an easy decision for a board to make.

This article addressed only some of the restrictions imposed on condominium associations for FHA approval and certainly the regulations are regularly being updated and supplemented. For more information on all of the restrictions and to stay up to date on changes to these regulations, you can obtain more information on the Community Associations Institute website at www.caionline.org.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.