New HOA Lending Rules
An already difficult condominium market is likely to become more challenging for buyers, sellers and lenders as a result of new underwriting guidelines adopted in Fall 2007 by Fannie Mae and Freddie Mac (the entities that buy most home mortgage loans). The revised rules respond to the mounting loan delinquencies and defaults that have bruised the bottom lines of just about everyone involved in financing residential mortgages. While this article is based on Fannie Mae’s new requirements, Freddie Mac’s are essentially the same.

The new policies require lenders to assess the financial strength of homeowner associations as well as the credit of the borrowers purchasing units in them. In addition to tightening the qualifying standards for condominium buyers, lenders must review the HOA finances which will, as an indirect result, push HOAs to focus more intently on their budgets and reserve policies than in the past.

Full Reviews Required. For lenders, the most significant procedural change is the virtual elimination of the streamlined "spot" loan approval process through which Fannie Mae and Freddie Mac have provided automated reviews of condominium loans originated for sale to them.

Fannie Mae’s new rules will require full project reviews for loans to individuals purchasing units for primary residences or second homes in new condominium developments and for loans to investors buying units in both new and established communities. Lenders financing multiple loans in existing communities (more than one loan in a given community within a year) will have to subject those loans to a full project review as well. Spot loans (single loans in existing communities) will be allowed only for borrowers making a minimum down payment of 10 percent, another significant change from the former policy, which allowed 100 percent financing for some condominium loans.

Clearly, Fannie Mae wants lenders to perform full-scale rather than limited reviews on the condominium loans that it buys. The company also wants HOAs to be primarily owner-occupied. Fannie Mae will not approve an investor loan unless at least 51 percent of the units are owned or, in a new development, under contract to owner-occupants or second-home owners. Under the full project review now required for most condominium loans, lenders must verify and warrant to Fannie Mae that:

1. The homeowner association has an "adequate" budget.

2. The budget allocates at least 10% of annual revenues to reserves.

3. The HOA holds funds equaling the deductible under the master insurance policy.

4. No more than 15% of the common area fees are delinquent by more than one month.

All of these changes are significant for lenders, but the delinquency limit is likely to prove most problematic. Homeowner associations nationwide are already struggling with rising delinquencies and foreclosures, exacerbated by a weakening economy and restrictive lending policies that had already begun to tighten before Fannie Mae announced the new guidelines. Even with an aggressive collection policy in place, it takes time to collect delinquent payments or to foreclose on delinquent owners.

Lenders, struggling with delinquency overloads themselves and under pressure to work with struggling borrowers, are delaying foreclosure actions and (in turn) delaying the point at which they must assume responsibility for paying the fees for the units they acquire. Under these circumstances, it is likely that large numbers of HOAs are already tripping over the new 15% delinquency requirement, or will be soon. The full impact is unclear, but at a minimum, this policy seems to be at odds with federal and state efforts to stimulate the sagging housing market. The policy also seems inconsistent with another recent Fannie Mae announcement telling loan servicers that they can increase the forbearance period on delinquent loans from four to six months, to give borrowers more time to seek financing alternatives that will allow them to avoid foreclosure.

The new guidelines will increase the paperwork and expand the potential liability for lenders, who must now warrant on each condominium loan sold to Fannie Mae that the HOA meets all of Fannie Mae’s legal requirements. In a follow-up memorandum clarifying the policy, Fannie Mae explained that for new condominiums, lenders must submit a formal written opinion from an attorney verifying that the HOA’s documents are in compliance, but for existing communities and smaller developments (2-4 units), Fannie Mae said the attorneys’ review "need not rise to the level of a formal written legal opinion."

Fannie Mae seems to be suggesting that the review for existing communities will be less extensive. In practice, however, this will be a distinction without a difference. No lender is going to warrant compliance for a new or existing development without obtaining an attorney’s written opinion on which to rely. And no attorney is going to provide that written opinion without performing the analysis necessary to offer an informed assessment. Whether they are dealing with a new development or an existing community, attorneys are going to have to review and analyze the association’s documents, and they are going to charge lenders for that work.

Having the attorney who represents the HOA or who prepared the original governing documents perform the review may reduce the cost, but there will be legal fees involved and lenders will almost certainly pass those expenses along to borrowers, increasing the cost of condominium loans.

Homeowner associations will also feel the impact of the new condominium standards. They will have to respond to requests from lenders seeking to verify that they have they have an "adequate" budget, a 10% minimum reserve allocation and insurance deductible funding that the new rules require. It’s not clear how lenders will determine that a budget is "adequate," but at a minimum, they will probably want copies of the budget and the most recent reserve study, plus some detailed background information explaining the reserve policies and reserve replacement history. Boards should anticipate these requests and develop policies for dealing with them. Owners should anticipate that boards will require them to pay for the reasonable cost of providing the information requested by lenders financing the units owners are trying to sell.

Pushing for Reserves. The new Fannie Mae policies will require HOAs not just to provide information, but to adopt policies they don’t currently have. The reserve requirement will likely prove most challenging. Most HOAs do not have adequate reserves or a funding policy matching the replacement recommendations of a reserve study, which many also do not have. Many HOAs don’t have any reserves at all. Few, have line items in their budget specifying that at least 10 percent of their annual revenues will be allocated for the reserve account. But here’s the critical bottom line: Lenders selling loans to Fannie Mae and Freddie Mac will not finance units in condominiums that do not meet the 10 percent-of-budget reserve requirement.

HOAs may be able to win a waiver if they can demonstrate that their reserve study supports a lower reserve to budget ratio. But Fannie Mae is serious about the reserve requirement and HOAs are going to have to be serious about it too. Arguably, the new underwriting standards for condominiums will require lenders and homeowner associations to do things they should have been doing all along. HOAs will become stronger financially, lenders will adopt more prudent policies, and everyone will eventually end up in a better place as a result.

By Seth Emmer of Marcus, Errico, Emmer & Brooks, P.C.    BACK

HOA reserve studies are a relatively new phenomena. The need for reserve studies became painfully apparent in the 1980s when condominiums built in the 1960s began to have widespread failure of common elements like roofing, fences, decks, paving, siding and other long life components.

In the 1960s, developers marketed condos as "carefree living" and promised buyers that maintenance and repairs would be taken care of by the association of unit owners. All individual unit owners had to do was contribute money to a pot and the rest was "handled". This all sounded too good to be true and was. Most of those developers failed to provide a long range plan (reserve study) and a funding plan to pay for very predictable and expensive future events. Not only that, the budget provided to the initial board was often woefully inadequate to pay for even routine day-to-day maintenance. It was all a setup to fail of nightmarish proportions.

To make matters worse, some of these developers wrote budget restrictions in the governing documents that prevented the board from increasing the budget without approval of a large block of members (sometimes 100% of them). These boards were effectively prevented from raising the money they needed to maintain the HOA and member assets. They started in a hole which just got deeper with passing years.

By the 1980s, natural deterioration had caused failure of many building and grounds components. It became apparent in states with large numbers of HOAs like Florida and California that better planning and requirements were needed to avoid this kind of predictable failure. In those states, legislation was adopted that required reserve planning. Thus, the concept was born and the need for qualified service providers to accomplish the work.

Unfortunately, there was no formal training available for reserve study providers. Those that engaged in it had varying types of backgrounds like accounting, engineering, building inspection, construction estimating or HOA management. Some had no related experience whatsoever. And no state licensing was required. This is still largely true today. Only Nevada has a requirement for reserve study providers (to get a permit).

So what should a homeowner association board or manager look for in a good reserve study provider?

Years of Experience. Reserve study providers learn their trade on the job. While having related education is helpful, actual experience doing the work is more important....the longer the better. Reserve study providers make judgments on designs and materials which have useful lives of 30 years or more. The longer the provider has been actually making these judgment calls, the more accurate they are. It’s the same reason you shouldn’t hire a brand new roofing company to put on a roof. This is intended to be a very long relationship. Don’t hire a company just because they want your business. Hire the company based on demonstrated experience.

Understands HOA Politics. As the name suggests, homeowner associations represent a collection of homes, not investment property. As such, the individual owners take a keen interest in how their home is maintained. So, while the board is authorized to make decisions, owners often weigh in on those decisions and watch closely how things are handled.

Understands HOA Operations. Doing repairs on owner occupied buildings creates additional challenges and costs. Painting buildings and sealcoating parking lots takes careful advanced planning and coordination. Just forget to warn residents in advance and watch the you-know-what hit the fan.

Ability to Communicate Clearly. The reserve study itself is a compilation of numbers, percentage rates, dollar amounts and descriptions. If the information is not organized in a user friendly format, the board and members won’t understand or use it. When soliciting proposals, always get a sample reserve study to make sure you "get it".

Report Complies with Governing Documents. The HOA governing documents are the guiding light for what goes into a reserve study. Many boards are surprised to discover their HOA has been maintaining things it shouldn’t and neglecting to repair things it should.

Report Complies with State Statute. A growing number of states have specific legislation that triggers requirements in the reserve study over and above what is required in the governing documents.

• Insurance Deductible. Lenders are now required to verify an insurance reserve equal to the HOA policy deductible.

• Contingency. Since the future is uncertain, adding a contingency fund of, say, $10,000 to address this often makes sense.

• Wish List. Additional items that don’t currently exist can be added to the reserve study to build funding over a period of years.

Credentials to Prove Experience. This is a big one. Since no formal education is available to train, experience and credentials are paramount. When it comes to credentials, the Association of Professional Reserve Analysts offers the Professional Reserve Analyst (PRA)™ credential to members who have a minimum of three years performing reserve studies and a work product that reflects all components of a well executed reserve study. For a list of PRA members, go to www.apra-usa.com

The implications of a badly done reserve study are long lasting. Don’t be fooled by low bids from inexperienced companies. Only consider proposals from those that have the credentials and experience to do this work. BACK

HOA Assessment Collections
The recent economic downturn has caused a slew of foreclosures, with potentially far more on the horizon. With foreclosures, lost jobs, and personal bankruptcies on the rise, homeowner associations are also hurting and faced with difficult decisions. Individual homeowners are defaulting on their HOA assessments at an alarming rate, leaving HOAs unable to cover their expenses. To have sufficient funds to maintain the common elements properly, HOAs may have to dig deeper into the pockets of paying homeowners by increasing assessments. But, this results in a Catch-22: Higher assessments trigger higher delinquencies.

But that is not the only consequence of high HOA delinquency rates. If an HOA turns to a lender for assistance, the lender may turn the HOA down if the HOA has too high a percentage of delinquencies. Unfortunately, the reason HOAs may turn to a lender may be the very reason they are turned away. In addition, lenders have also turned down potential buyers of homes in HOAs where delinquencies are above an unacceptable rate. The Oregonian recently ran an article on the impact of HOA assessments and explained the following: "Fannie Mae and Freddie Mac announced a year ago that it would no longer buy mortgages on the secondary market involving homes in homeowner associations suffering delinquencies of 15 percent or more. Absent a willing buyer on the secondary market, many banks are unwilling to lend money to buyers wanting to buy into the development." Jeff Manning, Another symptom of the downturn: Unpaid fees at housing associations, The Oregonian, April 18, 2011.

Some homeowners who have fallen behind on their HOA assessments have made it clear that they consider their HOA assessment to be the last bill they pay each month. When money runs short, the HOA may not see its monthly assessments from those homeowners. Consequently, HOAs that have never before turned to a third party to pursue delinquent homeowners have now turned to attorneys who specialize in HOA collections for help.

Law firms that specialize in HOA collections offer three basic fee arrangements:

Flat-fee. The flat-fee method caps the attorney fees to the HOA for each collection account. However, attorneys often pick and choose which accounts to accept under this method. Further, if an account is accepted, there is no time frame for a resolution of the account. In other words, collection accounts under a flat-fee arrangement can languish for months or years without a resolution under the hope that the delinquent homeowner may, at some point, pay the past due amounts owed.

Hourly. Attorneys charge their hourly rate in handling each collection account. Although this method may result in a quicker resolution of the delinquent account than the flat-fee method, the HOA is still responsible for the full hourly bill if a delinquent account is determined to be uncollectible. Without a cap on fees, the HOA may pay more in attorney fees than the amount of the debt.

Hybrid. This method combines the benefit of the flat-fee method (where attorney fees are capped) with the benefit of the hourly-fee method (where a fast resolution occurs) by setting a timeline to resolve the collection account. With higher rates of delinquencies and the necessity of resolving those delinquencies promptly, the hybrid flat-fee arrangement allows an HOA to cap its risk in attempting to collect on accounts while ensuring a timely resolution of those accounts.

As a result of the increase in delinquent accounts, HOAs are asking for faster and better information concerning the status of their delinquent accounts. To address this, some law firms offer online systems that allow clients to see exactly how their collection cases are progressing. This real-time access to information gives them the ability to make informed and timely decisions and to confirm that the law firm is moving the case forward.

As HOAs face increased delinquencies and the corresponding inability to maintain their administrative and maintenance responsibilities, and as potential homebuyers face the inability to obtain financing for homes in those HOAs, property values within HOA communities may likely fall. Accordingly, the fast and reasonable resolution of delinquent HOA accounts is not only desirable, but necessary.     By Phillip Joseph, Ball Janik LLP   BACK

By Christopher Gardner www.fhaprosllc.com   BACK

Insurance Requirements. Property, liability, D&O, flood (if in flood plain) and crime insurance coverage is required. Property (hazard) insurance must have 100% replacement cost coverage. Directors and Officers liability coverage (D&O) should be in place. Fidelity Bond/Crime Insurance is required for any project with 20 or more units. The coverage level must be at least equal to the sum of 3 months of HOA dues income plus the aggregate amount in all reserve funds. If the HOA uses a management company, the HOA's crime policy must explicitly name and cover the actions of the management company, otherwise the management company must have comparable levels of coverage and name the HOA as an additional insured. Over half of our clients have to increase the amount of their crime policy coverage to become compliant.

Litigation. Any current or pending legislation must be disclosed and the total potential exposure to the HOA must be fully explained. Routine items such as a mortgagee foreclosure do not have to be reported. The FHA will assess the risk the lawsuit presents to the overall health of the HOA and the marketability of the units, and will reject any sceanrios deemed risky.