Consider this couple getting ready to buy a condo. The husband is a senior manager at an engineering firm and has been with the same company for 12 years. His salary is $90,000 per year. The wife is an attorney with a legal firm and has been a partner with the firm for 10 years. Her income is $130,000 per year. They both save regularly in their respective 401(k) plans at work as well as consistent deposits in various mutual funds. Their credit is essentially spotless and they’ve recently checked their credit reports and there are no late payments, relatively small balances with different types of credit used. They apply for a mortgage to buy a condominium and want to put as little down as possible so they choose an FHA loan. But the application is declined.
Does that make sense? A couple with a seemingly perfect borrower profile can’t get a mortgage? Well, it’s not because the borrowers have something in their financial profile that keeps them at bay. It’s because the condominium project they want to buy into isn’t FHA approved. Perfect profile, but an FHA loan can’t be placed. Why? Because the condominium project doesn’t have its FHA approval.
FHA Condo Guidelines
Condominium projects go through a slightly different underwriting process compared to say a single family home or even a duplex. Why? The primary reason is how ownership is divided. When someone buys a single family home on a lot that person owns both the lot as well as the structure. With a condo, the buyers own the interior wall space of the individual unit while the common areas are owned evenly among all the individual owners. Common areas are spaces such as sidewalks, landscaping, swimming pool and workout facilities. A mortgage company has no claim on these common areas. If someone defaults on a loan for a condo, the mortgage company can’t foreclose on the common areas, just the ownership of an individual unit.
When someone wants to use an FHA loan to finance a condo, the project must be approved using established FHA guidelines. These guidelines must be followed to the letter or there can be no FHA loan. There are numerous guidelines, some minor and some not so minor. Let’s take a look at some of the guidelines condos need in order to get FHA approved.
FHA guidelines require that no individual entity can own up to 50% of the total units. If there are 50 units, no entity can own more than 25. This is a recent change as previously the limit was 10% of the total units.
No more than 50% of the units can be listed as non-owner occupied. FHA guidelines allow for rented properties but guidelines want more owner occupied properties than rentals. In addition, there can be no more than 50% of the individual units financed with an FHA loan.
There can be no more than 50% of the space dedicated to commercial space. Common commercial spaces are shops such as a restaurant, coffee shop or retail stores. Finally, no more than 15% of HOA dues can be more than 60 days delinquent.
Condominium projects are managed by the Homeowners’ Association, or HOA. One of the responsibilities is to make sure there are adequate reserves available to cover any insurance deductibles, maintenance and emergency repairs. At least 10% of income must be deposited in the reserve account.
There must be a master insurance policy in force that covers 100% of the replacement cost of the entire project. The insurance policy must have a general liability policy with a minimum amount of $1 million of coverage. There also needs to be a Fidelity Bond purchased that protects the owners against any management dishonesty or fraud for projects with 20 or more units. If the property is located in a flood zone, a separate flood insurance policy must be in place.
FHA guidelines require legally drawn and recorded Covenants, Conditions and Restrictions, or CC&Rs. Bylaws must be recorded, signed by an HOA Board member and dated. A recent balance sheet and income statement no older than 60 days must be provided.
FHA Loan General Guidelines
FHA loans are one of three government-backed loan programs. The other two are the VA and USDA program. With an FHA loan, should the loan ever go into default the lender is compensated for the loss as long as the loan was approved using proper FHA guidelines. This compensation is financed in the form of two separate mortgage insurance premiums. One is an upfront mortgage insurance premium but is not paid for out of pocket but rolled into the loan amount. The other is an annual premium that is paid for in monthly installments.
FHA loans can only be used to finance a primary residence and may not be used to finance a rental property or a vacation home, for example.
FHA guidelines require a minimum credit score of 580 yet most lenders establish a minimum score above that at 600 or 620.
The minimum down payment for an FHA loan is 3.5%. For this reason it’s extremely popular with first time home buyers as there is less cash to close with an FHA loan compared to a conventional loan. The FHA loan program is also very generous as it relates to financial gifts from family members. FHA loans allow for the entire down payment plus closing costs come in the form of a gift from a family member or qualified non-profit.
FHA Loans and Condos
It’s important to have a condominium project FHA approved. Condos are typically a lower cost alternative for first time buyers or any class of buyers for that matter. This is especially important for those saving up money for a down payment and qualifying for the mortgage. But without FHA approval a condo project is not an option. For this reason, many developers building a new condominium project also at the same time prepare the property for FHA approval as well as approval for other types of loan programs.
But it’s not always the lender’s motivation to get a project approved. The HOA can help get the property FHA approved by working with a lender to get the property listed as an approved project. A project that is already FHA approved means a seamless approval process and there is no concern regarding time frame or other issues when buyers use an FHA loan.
Buyers today can contact their loan officer to find out if a project is already approved. When a project is already approved by the FHA there is no need for a buyer to have the project approved all over again. Once approved, it’s forever approved. This approval widens the potential pool of buyers. Buyers can research the FHA website to see if a project is approved by entering the project name and address. If the project is FHA approved, buyers can then proceed with making an offer on the property.
The Author, Matt Herbolich, MBA, JD, LLM NMLS #1649154 is the Editor-In-Chief of Loan Consultants. He is a senior loan officer at USA Mortgage, a division of DAS Acquisition Company, LLC NMLS# 227262. Mr. Herbolich is also the Co Editor-In-Chief of The Gustan Cho Mortgage & Real Estate Resource Center at www.gustancho.com . Contact Matt Herbolich for your Real Estate and Mortgage Questions. USA Mortgage is a direct lender with no lender overlays on Government and Conventional Loans. Mr. Herbolich can be reached 7 days a week at 888-900-1020 by phone, on his cell at 786-390-9499 by either phone or text, or by email firstname.lastname@example.org.