Financing a Condo in Litigation
Buying and financing a condo unit is not all that different compared to financing any other type of residential property.
Mortgage lenders must still evaluate the loan application and determine the buyers have the ability to repay the debt and have established a responsible credit history.
Lenders will also verify there are enough funds available for a down payment and associated closing costs. There are of course other requirements but these are the basic guidelines. Finally, the lender makes sure the property’s value matches the price on the sales contract and is supported by recent sales of like properties in the neighborhood.
When establishing a value for a condo this is relatively easy as most projects have just a few floor plans and comparable sales are typically just a few doors down. But condos do have additional approval requirements that a single family home does not. Condominium projects must be approved by the lender after the project has completed certain condominium approval forms, insurance and budgets.
As a lender moves to approve a project that has not yet received such an approval, the lender presents various questions to the project management. For example, a project can be approved if more than 50% of the units are occupied by their owners. There needs to be sufficient insurance in place. Is there any commercial space on the premises and if so what is the total square footage of commercial compared to the total square footage of the entire project. These among other questions must be answered and approved by the lender. Once that approval is granted, the loan process moves like any other loan.
But one question can very well trump all the others- Is the Association involved in any litigation, current or pending?
If so, everything comes to a halt.
What’s the Issue With Financing a Condo?
Condominium projects are managed by the Homeowner’s Association, or HOA. One of the HOA’s primary missions is to enforce the rules of the project. These rules are known as Covenants, Conditions and Restrictions, or CC&Rs. Such rules might require owners to limit the amount of outdoor furniture on the deck or to restrict barbecuing outside. If pets are allowed, there may be a limit on how big your pet can be, and so on. Most projects can easily pass a lender’s project approval questionnaire because the developer is well aware that obtaining lenders’ approval is key to selling the properties. But even if every single one of the questions is answered to the lender’s satisfaction the question of litigation must be addressed.
Many lenders simply won’t approve any condo if there is any current or pending litigation whatsoever while a few do offer financing upon examining the details of the lawsuit.
When an HOA files a lawsuit there can be an additional homeowner assessment either paid as a onetime fee or a monthly fee. These additional fees will be added to a potential borrower’s debt to income ratios and if there is pending litigation a lender will wait to determine what those additional fees will be and how long they will be assessed.
Preapproval Letter Examples…
For example, a borrower applies for financing to buy a condo and the lender issues a preapproval letter. The borrower’s debt ratios are a bit high but the borrowers’ good credit overcame the higher ratios. The total debt ratio was at 44, a bit higher than most. Yet the HOA informed the owners of a lawsuit filed against a contractor claiming shoddy workmanship on the project’s HVAC system. The owners are required to pay an additional $250 per month until the suit is settled. This additional $250 now puts the borrower’s debt ratios at 47 and the preapproval is now rescinded. Because of the assessments, the application is declined.
If and until the lawsuit is settled, either in court or out, most lenders will shy away from approving a condo purchase with litigation involved. There are also HOAs that are “lawsuit happy” and are more than willing to file a suit at the slightest of disagreements. That’s why good real estate agents will review a condo’s history to see if legal filings are all too common. When an owner decides to sell a condo and there is litigation involved, they’ll either have to find an all cash buyer or find a lender who will finance a condo in such a situation.
Getting Approved For Financing a Condo
We can finance a condo that is currently in litigation but the project must be reviewed a bit further. There are two primary types of condo reviews, a limited review and a full review. A limited review requires much less information from the HOA compared to a full review. A limited review can ask as few as 10 questions and pending litigation is one of them. A full review can have five times as many requirements in addition to a full review of the budget, balance sheet and insurance coverage.
When we are financing a condo in litigation involved, for example, we review the projects’ budget and balance sheet. The CC&Rs will be looked over and no more than 15% of the owners can be delinquent on their HOA dues. With regards to the budget, there must be a line item listed for insurance making certain the HOA pays the property’s insurance directly to the insurer. As well, at least 10% of the annual income must be in a reserve account and the budget confirms that amount.
There are other requirements but the point is that a condo in litigation doesn’t always mean an automatically declined loan application. There are some additional steps involved and we need to have a comfort level with the nature of the lawsuit. But let’s be clear, sometimes in protection of the property owners it is the responsibility of the HOA to file a lawsuit when other efforts fail. When that protection is in process, there is still a way to get your loan approved.