Condos in Defect Litigation: What’s the Problem with Financing?

You’ve been searching for a quiet, comfortable condo within walking distance from downtown San Diego. You finally find the perfect place that has all the amenities you want, the space you need, and a gorgeous view overlooking the surrounding neighborhood, with the bay just on the horizon.

It’s perfect!

As you start discussing the property with the real estate agent, you discover that the condo may not be as perfect as you thought. It turns out the homeowners’ association is involved in defect litigation with a contractor.

Suddenly, your hopes are dashed. Or are they?

It’s a common assumption in the condominium world that any litigation will cause automatic rejection for applications on loans backed by the Federal Housing Administration (FHA). But is this really the truth?

Not exactly. While making loans on condos going through litigation can make financing more difficult, the truth is that numerous condos are going through litigation at any given time. It’s not uncommon, and with the right knowledge and a little assistance, it is possible to secure the loan you need.

Much, however, will depend on the specific type of litigation, so the first step is to understand the legal issue.

Getting Loans on Condos in Construction Defect Litigation

What’s the Problem with Litigation?

From the outside looking in, it can seem silly that basic litigation, which occurs everyday, everywhere, would cause a hangup in the financing process. The issue, however, is related to a potential buyer’s future expenses.

When seeking a loan, lenders will want to know how much money you will make in the future and how much money will be going out. For traditional single-family homes, the expenses are pretty predictable: mortgage, taxes, and a few other expenses. For condos, one of the monthly expenses is homeowners’ association (HOA) dues. The HOA uses this money to maintain the facility and provide specific services. If needed, they may also use HOA dues for legal fees.

As you likely know, legal fees can be expensive, so if an HOA is involved in litigation, they may need to increase the monthly dues. Litigation can also last for an unpredictable amount of time, so the dues could stay high for months on end.

As a lender, it’s hard to predict how much the borrower will be required to pay in HOA dues when there is litigation. Because the borrower’s expenses are hard to predict, lenders are less enthusiastic about issuing loans until litigation is settled.

Some Litigations Will Not Cause a Problem

Fortunately, not all litigations will cause concern. The lender can look at the litigation to determine the nature of the issue and make judgements on a case-by-case basis. If the lender finds that the litigation involves a minor issue that does not affect the safety or livability of the facility, then it’s likely a loan can be made.

Many types of litigations should not cause a problem, including:

  • Neighbor disputes
  • Litigation where the insurance carrier is providing legal fees
  • Litigation with the HOA as the plaintiff

Note: These issues could cause a dispute, but generally won’t affect access to loans.

What Types of Litigation Can Cause a Problem?

Every situation involving legal proceedings, structural codes, and specifics of financing will be dealt with on a case-by-case basis. So while it’s impossible to say that certain factors will affect every condo in every location, it is safe to say that, in general, the biggest legal hangup for lenders is when the HOA is suing a contractor over structural defects.

In many cases, you may have an issue where construction was completed but was insufficient of ineffective. Cases can include problems with the roof, such as leaking or drafty spots. They can include inferior building materials, such as windows that don’t function properly. They can involve poor workmanship, such as a poor drainage design or tile installation.

It’s also possible for the defect litigation to involve deficiencies in the design of the building. Sometimes architects create buildings that look great but do not function as required.

There are many different situations, but the bottom line is that if the homeowners’ association is suing a builder or contractor over an issue that affects the livability of the condo units, lenders tend to avoid making loans on this property.

Why is Defect Litigation a Particular Concern?

The real issue that worries lenders is when the HOA is suing a builder over a structural defect. If you think about it, it might actually seem strange. It seems that a lawsuit against the HOA, such as a slip-and-fall case, would be more costly; after all, if the HOA looses, everyone in the building will have to pay damages. This would increase the cost of living in the building, yet lenders are less concerned with these issues. (In these cases, the HOA’s insurance will cover the costs, so from a lender’s perspective it becomes a non-issue.)

The problem with defect litigations is that even if the HOA wins the case, it’s still not clear who will have to pay for the structural repairs. In many cases, even when the HOA wins and legally forces the builder to make changes, they will have to pay for the construction labor and material, as it may not have been factored in to the original contract.

How to Increase Chances of a Loan on a Condo in Litigation

While there’s not a lot you can do to affect the outcome, or even the expediency, of the litigation, you can provide information from the condo to your lenders. If possible, provide information that tells the lender about the case, when it may be settled, and what homeowners should expect to pay after litigation is complete. The more information you can bring, the better. With this information, lenders may be more likely to issue a loan, or, at the very least, pre-approve the loan for future lending when the case is settled.

Get the Right Information from a Lending Professional

If you are considering a condo that is currently involved in litigation, contact the team at San Diego Purchase Loans and let us take a look at your specific situation.

With a common-sense, personal approach to lending, we may be able to get you approved for an affordable loan on a world-class condominium, even while litigation is pending.

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I hope you enjoyed reading this article. It's my goal to keep you updated with the latest real estate mortgage news. I'm proud to provide you with 100% original and unique content. Subscribe now to get high quality real estate mortgage content and articles delivered directly to your inbox. Chad Baker is Regional Manager for LendUS. Chad is consistently recognized in the top 1% of mortgage originators in the United States 2011-2017. Got a question for Chad? Call (858) 353-8331 or submit your question online