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March 29th, 2012

FHA condo guidelines are strict for a reason

by Peter Miller

 

condosThere seems to be a bit of a dichotomy when it comes to the FHA’s financing guidelines for condos: on one hand, critics say the FHA’s financing standards are too conservative. On the other hand, the FHA is under scrutiny because its reserve levels are below the 2 percent minimum required by Congress.

These two criticisms are obviously in conflict. If the FHA offers a more liberal condo policy, it will result in more loans and more claims–and more claims are exactly what some critics are worried about.

The guidelines currently in place are actually quite fair and reasonable. For instance:

  • Condo projects must have a 50 percent owner-occupancy rate. This means a majority of units cannot be owned by investors
  • One individual cannot own 10 percent or more of all the units

The reason for these standards is that the FHA is an insurance program, and with insurance coverage comes premiums to pay. The FHA has a 1 percent upfront insurance premium and a 1.15 percent annual insurance premium. (There is a separate and lower set of insurance premiums for FHA loans originated before June 1, 2009 and current customers who want to refinance through the FHA.)

Why FHA premiums matter

The insurance premiums paid to the FHA are deposited into their reserve fund. This reserve fund holds the money which is used to pay lenders in the event a borrower defaults. If the FHA institutes smaller premiums and the number of claims increases, the reserve fund shrinks.

Smaller reserves are not a good idea for any insurance program, especially one operated by the federal government.

So, what would happen if the FHA made their condo guidelines more liberal?

The upside of less-stringent guidelines

We would surely sell more condos and that would help certain marketplaces—like south Florida, Las Vegas and southern California—that were hardest-hit by the housing crisis. Furthermore, a more robust condo market would mean additional demand and perhaps even higher condo prices. In a sense, this would protect the FHA because higher prices are one way to reduce claims.

For example, if an owner defaulted on a condo that was bought for $100,000 but the value increased to $105,000, there’s an extra $5,000 in equity which can be used to offset claims, $5,000 that didn’t have to come from the FHA reserve fund. To this point, no taxpayer money has been used to underwrite claims against the FHA. Most of the current losses stem from loans made between 2000 and 2008.

However, since then, the program has taken steps to protect itself with tighter lending standards, requirements for more money down and a better premium schedule.

The guidelines should stay as is

Since the housing market remains troubled and vulnerable, especially in the areas hardest-hit by foreclosures, the FHA’s condo guidelines should remain intact. If the FHA were to relax their guidelines, they could expose themselves to greater risk. So while more condo loans might sound enticing, the reality is that more FHA condo loans also represent more risk at the very time when the FHA is seeking greater stability.

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One Response to “FHA condo guidelines are strict for a reason”

  1. Jason Brand Says: March 30th, 2012 at 12:28 pm

    Peter,

    I understand the debate that is going on regarding condo financing is quite complex, and I further understand the points that you have made in your article. However, the biggest obstacles that we are seeing regarding the current guidelines weren’t mentioned by you–namely 1) the 15% delinquency rate with delinquency defined as over 30 days and 2) the 10% reserve requirement for COA’s.

    It was recently reported that only 2100 out of 25000 COA’s had qualified for recertification under the new guidelines since the elimination of the spot approval process. And even those that are still approved in the FHA database may not be currently approved for financing because, in a particular month, the delinquency rate may have hit 16% or more or the condominiums don’t have 10% in reserves thus immediately disqualifying the COA from financing. Additionally, the 15% delinquency rate includes properties that are in the foreclosure process or are bank owned. And let’s be honest–the banks are rarely paying the condo fees on these properties. As a result, FHA financing is pulled from the community which hurts not just one property but every unit in the entire COA. This also affects VA financing, perfectly good borrowers from refinancing, and perfectly good buyers from purchasing in these COAs. When the only means of buying a condo is cash or investor, you have limited the supply of buyers and almost instantly crushed values of the entire community.

    Bottom line, like everyone else, I agree that lending standards were too loose in the early 2000s, but lately they are too strict and some easing of the restrictions must occur for the real estate market to fully recover so that the economy can fully recover.

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