Q: In trying to sell a condominium, the buyer was denied a loan due to the fact the condo/management association did not transfer 10 percent into the reserve fund. What are the requirements for reserves and do we have any recourse against the management company for failing to fund the reserve fund properly?
A: One of the results of the Great Recession and housing crisis is that secondary mortgage market leaders Fannie Mae and Freddie Mac, which are both under government conservatorship, have increased certain requirements relating to condominium associations. The requirements are designed to make sure loans have a lower associated risk of foreclosure.
In the boom years, developers would throwing up condo buildings left and right, and lenders were loaning money to almost anyone with a decent-enough credit score and a pulse. But the interest rates were relatively high. When the Great Recession began back in 2007 and millions of Americans lost their homes, there were suddenly too many condos available for the number of condo buyers. Prices tanked, leaving many condos underwater. As condo owners lost their jobs and were unable to refinance, many condos were abandoned and went into foreclosure.
As condo owners defaulted on their loans and stopped paying their condominium assessments, condominium developments didn’t have enough money set aside in reserves for the proverbial rainy day. Lenders that did foreclose had to make payments to the condo buildings and to cities for property taxes. Fannie Mae and Freddie Mac had to kick in billions of dollars to make up the difference.
The result was that lending guidelines now require condominium associations to have a minimum amount of money deposited into the annual reserves and the general is 10 percent of the annual budget goes into reserves.
While it sounds nice to make sure that condominium associations are accumulating a cushion for capital expenditures or for other expenses, the fact that a condo building hasn’t accumulated the requisite amount shouldn’t necessarily preclude a borrower from purchasing property there.
In some cases, depending on the amount a borrower wants to get from the lender for the purchase, the lender can waive the condominium requirements. The more money a borrower wants to borrow, the greater risk the lender takes and the stricter the lender will be on the guidelines. A borrower who intends to borrow 95 percent of the purchase price will have a harder time obtaining a loan than a borrower only looking for 50 percent of the purchase price.
While many larger condominium associations might have already transferred 10 percent of their budget into reserves, not all of them have and not all of them will. Some condominium associations are still struggling with foreclosures and short sales and may not have the ability to get more money from their owners.
If you live in this condominium association, you can work with the management company to see if it can increase the property’s budget and show enough excess cash from the owners to transfer the required 10 percent or more into the condominium reserves.
But you can’t blame the management company if the board of the association does not pass a budget that requires higher assessments and the contribution to reserves. You can fault the management company if it hasn’t informed the association that lending guidelines now might require this contribution. The management company can only follow the budget that the board of directors of the association passes and approves. The management company would not and should not arbitrarily decide where the homeowner’s money should go.
You need to keep in mind that the condominium association and the management company might want stronger, more qualified buyers coming to the property. If the annual reserves contribution isn’t made, that alone will naturally limit the number of potential buyers able to purchase in the condominium development. The result might be better-qualified buyers but the pool of buyers able to buy in the development may be smaller.
(And if there are fewer buyers able to purchase property at the development, prices will rise more slowly, not at all, or may even fall.)
You can get more information on the requirements that Fannie Mae has for condominiums at the Freddie Mac website (http://www.freddiemac.com/learn/pdfs/uw/condo.pdf). There you will see that not only do they require a 10 percent payment to reserves, but they have other requirement relating to the maximum number of homeowners that may be late in their assessments at any time in developments (15 percent if there are 30+ units) and the number of units that must be owner occupied (51 percent).