Whether a condo is mortgageable or cash only, borrowers need to understand that they are buying in to a Home Owners Association, HOA, and they need to understand what the association IS doing and what the association IS NOT doing to limit risk. A borrower needs to understand what their responsibilities are within that association for their investment. There are situations where having a very light HOA is exactly what you want and there are some situations where having a very restrictive HOA is what you want. As a buyer you need to have a good understanding of what the HOA will be doing for you. It is always suggested that you review current condominium documentation, minutes, financial reports, insurance policy declaration pages, etc. (condo docs) as a part of any condo purchase.
When we say “mortgageable vs. non-mortgageable” we’re talking about whether the HOA has insurance that complies Fannie Mae and Freddie Mac guidelines, aka, the Agencies. Individual banks can determine if they are not going to sell a mortgage to the Agencies or not. If they choose not to sell the mortgage, then they can determine what level of risk they are willing to take. Loans not sold to the agencies are typically referred to as portfolio loans. As a portfolio loan the lender makes the credit decision based on their internal criteria not the Agencies guidelines. Portfolio loans are granted to very strong borrowers with excellent credit, and sufficient reserves to offset the risk presented. In this case that additional risk is the risk that the HOA takes and therefor the collateral may not be fully insured. Since the lender is taking additional risk, the terms of portfolio loans are generally not as favorable as an Agency backed loan.
The following 3 items are ones, that, should an HOA have them in place, would most often be deemed non-mortgageable by the Agencies. As I mentioned previously they may be just fine for most buyers.
# 1 Self Insuring Condo Associations
A condo may decide to fully self-insure. Typically, this process begins with a condo association determining their tolerance for risk. Some condo associations may have large cash reserves set aside for possible future losses. They choose to self-insure because they have those large reserves and their loss history support that those reserves will be sufficient to make repairs necessary should a loss occur. We need to understand that commercial insurance has two key components, loss basis, and profit for the issuing company. Self-insuring Associations are eliminating the profit for the issuing company but accepting, and therefore, preparing for, the eventual losses that will occur.
As a buyer you want to look at the reserves the condo association has and are those reserves sufficient to cover any damages you think they might have in the future and what’s the HOA’s plan to rebuild those cash reserves if they are expended.
#2 Some condo associations choose to not comply with all The Agencies guidelines and still maintain some insurance coverage
Some condos may not want to fully self-insure but may choose to partially insure or insure at levels that are deemed insufficient by The Agencies. The Fannie/Freddie guidelines tend to be very stringent and focus on limiting the buyers risk in a loss event by requiring 100% coverage.
For example, one requirement by The Agencies is a 5% deductible. Many HOA’s will have sufficient cash reserves where a 10% deductible may be sufficient. By adopting this deductible, the HOA could save insurance premium and use that savings for other amenities or pass that savings on to their owners.
#3 Maximum Loss for a windstorm event
The third thing I see Associations do that puts them outside of the Agencies qualifications is they will have a Maximum Loss provision in their Master Insurance Policy. Because the vast majority of our buildings on island are concrete construction, those buildings hold up pretty well to windstorm events. An HOA sustaining a 100% loss is extremely rare, so some HOAs have decided to purchase what I refer to as a “maximum loss” policy. This policy typically limits windstorm coverage only, so other insured hazards would not be affected, however the Agencies require full insurance for all hazards.
In cases such as this the buyer will want to know that the HOA has completed an analysis as to what IS NOT going to be damaged and what IS going to be damaged in a windstorm event. If the HOA feels like 30% of the value is at risk then they may purchase maximum loss policy that limits windstorm payout to 30% of the coverage. This is generally stated as a dollar amount not a percentage, i.e a $10,000,000 Master Insurance Policy, may limit windstorm coverage to $3,000,000
Using the above example if the HOA sustains $4 million in losses during a single event, the insurance company would cover the $3 million, the HOA would come up with the remainder.
I guess in summary….It’s all a risk game. The Agencies were created to manage risk to their investors and provide an outlet for lenders. The HOAs are trying to keep the quality of the association high, and the cost of ownership as low as possible for their owners. Those risk tolerances do not always align to make a condo mortgageable by the Agencies.
