New Features Will Mean a Smoother Transition and More Condos Eligible for FHA Financing

FHA has pushed back their new condo approval process, again. The new condo approval guidelines were originally due to go into effect back in October. Then  it was moved to November, then December, and now we have one more push back to the beginning of February. The reason they keep pushing these dates back is that they need to get the process right, and there is a running battle over how to do this. Part of this is due to the fact that under these new rules, it will be the FHA Direct Endorsement lenders who will need to certify that the condo project meets all the guidelines. This is a much higher level of accountability than lenders had before with the FHA Spot loan, and the lenders are taking on more risk (If any of the information they certify turns out to be wrong, they have to buy back the loan) and once they approve one condo unit, the project is approved and any other lender can come in and place FHA loans in that project, without having to go through all the extra documentation. There are still a lot of holes in how the process will be administered, and the lenders want to make sure they aren’t taking on too much additional risk for a small potential reward. FHA is also putting together a more advanced Condo Search Tool which will list all the condo projects (including smaller buildings – as low as 2 units) that have made the list, and it takes time to make sure this is bug free.

Another part of the reason this change in the process is coming on so slowly is that FHA is being torn in two directions. One goal is to make sure that FHA only makes solid loans to keep the program solvent. There has been a lot of talk about how FHA is the next time bomb, that loan quality is eroding and as FHA dips below their required reserve level they will need a Government bailout to continue operating. This is a valid concern. Fannie Mae and Freddie Mac, the former pillars of the mortgage industry, have already been taken over completely by the government, and this week Freddie Mac announced that they would need another hit of federal funds. All the major private mortgage lenders have already either bitten the dust or accepted massive bailouts to stay in business. So if FHA followed suit and needed more funds it wouldn’t be a big surprise. This is a function of high unemployment and a distressed real estate market. The competing view here is the reality that FHA has now become the 1,000 pound gorilla in the mortgage market. Especially the condo market. So many condos no longer meet conventional guidelines, and without FHA financing, the amount of buyers able to buy a condo would be much smaller.

Going forward, FHA has to do what it can to carry the real estate market on its back, while maintaining a high loan quality. This is a delicate balance, and it takes time to get the right mix. The new mortgagee letter which pushed back the start date, did clarify some issues and laid the path for a smoother transition to the new process. Here are some highlights:

All  previously approved condo projects will remain on the FHA approved list until at least December 7, 2010. Under the new program, every lender will need to submit their first 5 test cases directly to HUD for approval. As originally written, the new process would only grandfather in condo projects that had been approved in the last 12 months (October 2008), and all others on the approved list would need to resubmit for a new approval. This promised a backlog of applications and a long wait for approvals. This letter extends the approval of all condos currently on the approved list until near the end of next year. The Direct Endorsement lenders will be required to verify the current condition of the project (the amount of non owner occupied units, amount of FHA loans in the project and how many owners are in arrears of their association dues), but this will take some of the pressure off and allow more time for the new process to get up to speed.

The requirements are eased for the first year, making more condo units available for FHA financing. The pre-sales requirements for loans taken between December 7th of this year and December 31st of 2010 will only need to be 30%. This number moves up to 50% in 2011. The percentage of FHA loans allowed in each project will be 50% in the same time period (then lowered to 30% in 2011) and under certain specific cases, it could be up to 100% FHA. These changes mean that more new construction condos will be able to go with FHA financing, and this is a big advantage over conventional financing (where they are requiring 70% pre-sales in most cases).

Under the new guidelines a reserve study is no longer required.  This was one of the big sticking points in the original proposal, as a reserve study would cost money and put more burden on the lender. This is now changed so that FHA is coming in line with Fannie Mae and Freddie Mac, and requiring that the condo’s budget has adequate funds for replacement reserves, capital expenditures and deferred maintenance. This usually means 10% of the budget as a holdback.

The new guidelines allow previously excluded units including 2 and 3-unit condo projects, and condos with a first right of refusal in their decs and by laws to be financed through FHA. even 50% from 51%, allowing a right of first refusal in the condo declaration will now be allowed. These changes will allow more condos to qualify for FHA, and at the same time make it easier for lenders to administer the program, while keeping safeguards in place to keep the program solvent. It seems like FHA is striking the right balance.

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