So did your last condo transaction feel more like a hobbit adventure into Mordor than a standard real estate deal? If so, that is definitely understandable. Financing a condominium can have an unpredictable outcome, which nobody ever wants in a transaction. What is it about condominium financing that adds such a layer of complexity? Over the next few posts, we will explore this topic. We will identify unique condo financing criteria, as well as tips to hopefully smooth out this process to ensure a successful closing. Let’s start by looking at the factors that make financing a condominium different than financing a single family dwelling. Some are obvious, but these factors affect a mortgage approval in ways that don’t come in to play when financing a single family home.
- Legal Structure. When one purchases a condominium, the result is individual ownership for what exists within the walls, & then a non-exclusive common ownership interest in what is considered “common elements”. This is typically anything that is outside the walls of the condo unit purchased, such as sidewalks, landscaping, pools, clubhouse, etc. To a great extent, the quality & condition of these common elements can impact the value of the individual units, but no “one” owner can make any changes to these common elements.
- Existence of a Master Deed & Bylaws. The condo master deed can be viewed as a “blueprint” of what makes up the condo project. The master deed defines the elements & ownership aspects of the condominium project. The master deed will also indicate how many units will be in a condo project. This last point is important: a lender will typically be reluctant to lend if a condo project is not complete. One strategy to consider here is to find out the “phasing” of a condo project. In some cases, a condo project will be built in different stages or “phases”. For example, a condo project might consist of 100 units, built in 4 phases of 25 units each. In this case, if the unit being purchased is in a phase that is complete, financing will generally be available even if the rest of the project is not complete. The bylaws will establish the “rules of the road” for the unit owners: what kind of plants can be planted, are you allowed to build a deck off of your unit, when are you allowed to set out your trash, etc. The bylaws also create the structure for the Association. This is the group of unit owners, who then elect officials to govern the condo project, vote on changes, & maintenance issues, & enforce the bylaws. In short, a lender will want to know that there is nothing in a master deed & bylaws that would prevent them from enforcing lien rights when a condo unit is used for collateral on a mortgage. This leads us to:
- The Association. Once again, the group of unit owners that govern the condo project, enforce the bylaws, & vote on operational & maintenance aspects of the condo project. The association will need to be able to answer a variety of questions for a mortgage lender before that lender will be willing to lend in the condo project. Some associations use a management company to handle the daily activities needed to manage the condo project.
- A Budget. A good homeowner will always try to operate within their own family budget. When one owns a condo, the association manages a budget as well. Each unit owner contributes to this budget in the form of monthly dues. From a lender’s perspective, we need to know that a condo project’s budget is adequately funded to maintain & insure the common areas. If a condo project budget is mismanaged, then the value & marketability of a lender’s collateral can be negatively impacted. During the market implosion a few years back, many associations struggled because some unit owners could not afford their monthly dues. Plus, the number of vacant units increased due to foreclosure, or simply the inability of an owner to sell in the depressed market. Therefore, associations had fewer dollars coming in to manage the condo project. As a lender, we could have a wonderful unit owner living in a great condo unit. But if the budget is compromised, the value of that unit could suffer, creating great risk for the unit owner as well as the lender.
This list is not necessarily all inclusive. As you can see however, these factors create a very different finance landscape when compared to obtaining a mortgage for a single family home. In the next post, we will explore some of the particular requirements for financing a condominium. We will also explore a list of some factors that can make a condo project ineligible for standard mortgage financing, & what can possibly be done to remedy such a situation.
In closing for our first part of this post, consider that condominiums appear to be in high demand at the present. These transactions, while potentially troublesome, should not be feared or avoided. As experts in our industry we all owe it to our customers to stay informed about these unique requirements, and need to be well versed in setting proper expectations for buyers & sellers. In the spirit of the J.R.R Tolkien reference at the beginning of this post, remember the famous poem: “All that is gold does not glitter, Not all condo transactions are lost…” or something like that. Stay tuned for part 2!
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