FHA policy shift leaves many condos ineligible for financing

Language buried in CC&Rs puts entire projects off limits for FHA loans

Is FHA intentionally targeting condominiums, trying to exclude hundreds or thousands of them around the country from qualifying for financing under its mortgage insurance program?

FHA officials tell me absolutely not. But an abrupt new “no-tolerance” move by the agency has large numbers of condo associations across the country wondering whether FHA is looking to dump them.

Florida condos image via Shutterstock.
Florida condos image via Shutterstock.

The issue is technical and involves language buried away in condo associations’ core legal documents — their “CC&Rs,” or covenants, conditions and restrictions. Buried in many CC&Rs is language that prohibits units in the project from being leased for periods of less than 30 days.

But many associations’ CC&Rs have for decades contained a seemingly innocuous exception for units taken back through foreclosure by mortgage lenders or investors — language insisted upon during the 1980s and 1990s by Fannie Mae and Freddie Mac to provide more flexibility for them in the management of their real estate owned (REO) properties.

Until a few weeks ago, according to condo association leaders and industry groups, FHA showed little interest in the 30-day language in certifications and recertifications of projects for insurance. Then suddenly, without warning, it began rejecting applications solely because the underlying CC&Rs permitted transient leases by mortgagees “in possession” of foreclosed units. According to HUD lawyers, this violates a 1994 amendment to the National Housing Act.

The Community Associations Institute (CAI), which represents 30,000 homeowner associations and management companies, said it immediately began receiving complaints from members outraged by what they view as a sudden, unannounced policy shift. Jon Eberhardt, CEO of Condo Approvals LLC, a firm that assists associations get through FHA’s certification hoops, told me last week that “FHA has no idea how many (condos) this will affect” — most likely in the thousands.

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For example, Eberhardt estimates that up to 30 percent of all condo projects in California, including many previously certified by FHA, have the short-term leasing exception in their CC&Rs but now face potential loss of eligibility. In a number of states, he says, language like this is routinely present in condo documents.

The grim reaper at FHA is rejecting certifications because of arcane language in documents that it never objected to before and that no one has connected with any statistical risk of default or foreclosure.

A little background: FHA does not insure “spot” loans on individual units; the entire project must be certified and meet the agency’s requirements on budgets, reserves, insurance, owner-occupancy and other tests before any one unit can be financed with an FHA-insured mortgage. Put another way, if the condo association hasn’t passed FHA’s certification procedures, no one in the project is eligible to sell a unit using FHA insurance, and no buyers can obtain FHA financing.

Yet FHA’s low down payment loans have served for decades as an important route to homeownership for young, moderate-income, first-time purchasers, many of them minorities. More recently, the agency’s approval of a condo project for financing also has been the only way for older unit owners to obtain a reverse mortgage to help with personal expenses. FHA’s reverse mortgage program dominates the field and accounts for roughly 95 percent of all loans outstanding.

The point here: FHA financing is crucial for certain segments of the housing marketplace. If it’s suddenly not available or associations find compliance too costly, large numbers of owners and potential buyers — including many of the “underserved” that FHA is statutorily required to assist — will get cut out.

According to officials, 26,652 condo associations nationwide are certified for FHA insurance. But that number has dropped sharply in recent years — down from about 40,000 — as the agency has steadily toughened its certification procedures.

When rejected condo associations have complained to FHA about the sudden and unannounced change of policy on short-term leasing, CAI officials and Eberhardt say they’ve all gotten the same steely answer: Amend your CC&Rs and get rid of the offending language.

But that’s no simple task and FHA knows it, argues Eberhardt. Changing CC&Rs “requires in most cases a supermajority vote and (sometimes) even the vote of the mortgage holder,” he says. “Such a vote is used for exceptional purposes” only and cannot “be undertaken lightly” by a condo association. It also “usually involves an attorney and costs many thousands of dollars.”

As a result, Eberhardt added, “few (association boards) will entertain a change to their CC&Rs unless it is for a full tuneup (of the documents), but not to change a HUD technical issue. They will forgo HUD approval in the face of such a rejection.”

Which, in turn, will further reduce the number of condos eligible for FHA financing, and in some cases, reduce the values of individual units cut off from buyers who need FHA financing to swing a purchase.

So why the sudden switch if FHA itself denies that it wants to reduce its traditional role in the condo arena? Why no advance notice and no willingness to provide a little wiggle room on an issue that the agency itself has ignored previously?

FHA officials last week would only tell me that they “are aware of the problem,” but have limited scope for compromise because federal law prohibits the language contained in the associations’ CC&Rs. Once HUD lawyers spotted the noncomplying language in some condo project applications, FHA “had no choice” but to take action immediately.

FHA is interested in finding some sort of accommodation, officials said, and they are consulting departmental lawyers this week.

But meanwhile, if you are a unit owner, board member or a realty agent representing buyers or sellers of condos nationwide, be aware: The grim reaper at FHA is still rejecting certifications because of arcane language in documents that it never objected to before and that no one has connected with any statistical risk of default or foreclosure.

Ken Harney writes an award-winning, nationally syndicated column, “The Nation’s Housing,” and is the author of two books on real estate and mortgage finance.


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