If you’re looking for a home to buy you certainly have your fair share of property types. Certainly the most common property is the single family home, a detached property located in a residential neighborhood. You can buy a duplex. Or a 2-4 unit property sometimes referred to as a four plex. You can buy a town home or a property located in a Planned Unit Development, or a PUD. And if you’re looking in a more urban or suburban area you might also be looking at a condominium project.
In higher density areas, condominiums are a popular choice. And if you’ve narrowed down your search between a condo downtown or a single family home in the ‘burbs, you might also want to consider any differences in financing costs. There can be a difference.
What is a Condo?
A condo is legal definition and description of ownership. When you own a single family home on a lot, you own the lot and both the interior and exterior of the structure. With a condo, you own the interior space of your individual unit, often referred to as “walls in.” You then have an equal share with the other owners in the project the common areas. You and everyone else have an equal share in the swimming pool, workout facility, office space, sidewalks and landscaping. That’s the legal difference between a condo and a single family home. As it relates to financing however, there are a few extra steps involved.
A condominium project must be approved using standards set by Fannie Mae, Freddie Mac, VA or FHA. When a project is approved it is commonly referred to as “warrantable.” If a project has been previously approved by a lender or directly through one of the agencies directly, there are some basic requirements that have been met. There are two types of a project approval, a full review or a limited review. A full review is an extensive process and one that the original developer should have initiated during the construction process. Or, if you have a down payment of at least 10%, then a limited review can be performed.
A limited review requires much less paperwork but does require the lender to verify the information provided conforms to lending requirements.
• The project phase must be 100% complete.
• The Developer must have transferred ownership to the Homeowners Association of unit owners.
• At least 90% of the units have been sold and transferred to the owners.
• The units must be separately metered
• The units must be occupied by at least 50% of the owners
• There is no current or pending litigation
• No entity can own more than 10% of the total units in the project
• Commercial space must be limited
• Minimum insurance coverage including liability
• Budget must include at least 10% of the total annual budget for reserves
These and other requirements must be met in order to receive the most favorable financing terms. If a project does not meet one or more of these requirements the project is then deemed “non-warrantable.” A non-warrantable condo can still be financed, most often with the absence of any current or pending litigation, yet with higher rates and a larger down payment requirement. If the project is warrantable and the project is approved the interest rates will be as competitive as most any other type of property. Before you get too much further in the condo process you should first make sure the project is in fact not only warrantable but previously approved.
Interest Rates Compared
For an approved condo you can expect interest rates to be slightly higher compared to a similarly priced single family home. This can be as much as 0.125 to 0.250% higher. When lenders approve a loan for a condo and sell that loan in the secondary market there is an additional fee which is compensated by the lender with a higher rate.
There is a slightly higher risk associated with a condominium hence the bump in rate. Historically, default rates for condos have a greater risk of default. Not much, but enough to warrant a rate increase to offset the assumed risk. To offset the increase in rate, borrowers can place a down payment of at least 25% of the sales price.
When comparing interest rate options you should also consider other HOA fees. The homeowner’s association requires an annual HOA fee which covers property management, insurance, maintenance and other expenses. HOA fees can be inordinately high which can add to the cost of the monthly payment. On the other hand, because condo owners don’t directly pay for hazard insurance, there is a reduction in insurance costs. Instead, owners purchase a “walls in” policy which covers the contents of the interior of the individual unit.
You can compare interest rates with a condo and a single family home but you should also compare the total costs of ownership. With a condo, you can expect to pay not just the principal and interest payment but also an amount for property taxes and HOA dues. With a single family home the monthly payment is the principal and interest payment, property taxes and insurance.
One other cost that should be considered with a condo is referred to as a “special assessment.” An HOA has the authority to asses property owners a fee to help pay for one-time charges such as legal work, unexpected structural issues or other non-planned expenses. A special assessment can be paid in one lump sum or the HOA can arrange for installment payments.