The law of unintended consequences kicks in again this week, and this means a big change for the condo market here in Chicago and around the country. The FHA spot loan expires as of February 2^nd, so this is the last week that spot loans will be accepted. HUD (the Department of Housing and Urban Development) which administers FHA, is now switching entirely to a new condominium approval process. While this looked like great news when it was first announced several months back, the reality is that this is turning into a major headache for lenders, and condo buyers. For now, there will be fewer condo properties that are eligible for FHA financing, making it harder for buyers without a large down payment to get the best financing.

Over the last few years, as conventional guidelines and extra mortgage insurance regulations made condo financing tougher, the FHA spot loan became one of the best routes to get condo financing. FHA requires that condos be approved and meet their guidelines. Back in the old days, developers would petition for condo project approval when they were still building or rehabbing the project. Over the years though, FHA became close to irrelevant. The approval process was paper work intensive and a pain to go through, the FHA max mortgage didn’t keep up with the increase in home prices, and especially as the market boomed, private lenders came in with all sorts of alternatives for low and no down payment condo buyers. So over the last 15 years (excluding last year) few new condominiums here in the Chicago area have been added to the list. The FHA spot loan process filled this void. The FHA spot loan was a way to approve one condominium unit, not the entire building. This was part of the purchase process, and while we were going through the work of approving the borrower, we would approve the condo unit at the same time. This was a great program and it helped a lot of buyers buy with all the benefits of an FHA mortgage. But there were some big problems with the spot loan.

• The FHA spot loan didn’t apply to smaller buildings, so those buying condos from converted 2,3 and 4 units couldn’t use the program.
• The FHA spot loan didn’t accept condos which had a “first right of refusal” language in their Decs and Bylaws. The reasoning behind this was that this cause could be used to discriminate, but the reality was that most of the older properties had this clause.

From HUD’s point of view, the spot loan was a problem because they didn’t have control, and loans were closed and funded on properties that didn’t meet the guidelines. So they came up with a new condo approval process which was designed to fix these problems. The new condo approval process allows properties that have the right of first refusal clause, and it can be used with projects as small as 2 units. Under the new process, you could approve a new condo in two ways. First, you could go directly to HUD (HRAP) and file all the paper work directly with them, which a lot of smart developers have been doing over the past year. The second way was what appeared to be most promising. FHA Direct Endorsement lenders (I work for one) would have the authority to approve the projects on their own (DELRAP). This could work like a spot loan in that when the borrower bought a new condo, as part of the approval process, we would scrutinize the building and approve the project at the same time. Once a direct endorsement lender approved a project it would be added to the FHA approved list and then any other lender who made FHA mortgages was able to also provide FHA financing for the entire project. But here is where the law of unintended consequences kicks in.

Under the new FHA condo approval process, HUD needed more documentation, and more express warranties from the direct endorsement lender approving the project. If the lender got something wrong – and some of the documentation needed is hard to insure accuracy – this means the lender is on the hook with HUD for any loans made in the project. This means a lot of risk for a small reward. The deadline for this was extended twice while HUD tried to iron out the kinks and get the lenders on board, and they allowed the spot loan to continue as a way to keep financing open. But now the spot loan is about to become history, and the new improved process isn’t ready to take its place.

Condo buyers can still buy anything that is currently on the FHA approved condo list, but what are the options if they want to buy in a building that hasn’t been approved? And how about developers (or those who want to sell a condo, including the seller and the Realtor) what options do they have for getting their project approved? Being able to finance with FHA is a a real competitive advantage in this market. And properties with FHA financing are selling quicker and this appears to make them more valuable. There are also a lot of newer properties that don’t meet conventional guidelines because they haven’t sold and closed on enough units, but would be eligible for FHA financing.  Tune back in, and I’ll have more on these situations shortly.

Peter Thompson 630-479-6424 First time home buyer loans

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