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FHA Under Pressure to Bring Back Individual “Spot Loans” for Condominium Units

John Russell April 15, 2014

There is finally some good news for condominium unit owners who’ve been frustrated by the FHA’s prohibition on “spot loans” in developments that haven’t obtained certification. Pressure from real estate advocacy groups is causing the FHA to seriously consider relaxing the ban and bring back spot loans.

Ken Harney, a nationally renowned author and expert on real estate and mortgage finance, wrote in a recent column on April 8, 2014 that “Officials are mum on the details and timing, but they confirmed to me on Friday that reviving this key financing option is now under active study. The main reason: FHA is under growing political and trade group pressure — NAR and the Community Associations Institute especially — to do so.”

Why is this important? A significant number of condo association boards have either chosen not to apply to FHA for approval of the entire development, or are unable to do so because their associations don’t meet the standards or they feel they can’t afford the cost of hiring an attorney or other professional to assist them. Under current rules, without FHA certification of the project as a whole – based on evaluations of the association’s financial accounts, reserves, insurance, renter-to-owner ratio and a long list of other factors – no unit in the development is eligible for an FHA mortgage.

This concept particularly affects moderate income, first-time and minority buyers — and its ironic, considering that the name of the agency has “Fair Housing” in it.

If a condo association does not have pre-approval from the FHA, existing unit owners who want to obtain a reverse mortgage to tap their equity cannot qualify. Harney commented, “The FHA’s home equity conversion mortgage (HECM) program dominates the reverse mortgage field and accounts for an estimated 90 to 95 percent of all volume. Without access to FHA, seniors who live in a non-certified condo project are cut off from a major potential source of needed cash to pay bills and support their retirement years.”

The inability to obtain spot loans has a direct affect on the selling prices of condos. I have had several clients selling condo units who lost money when the only buyers interested only qualified for low down payment FHA financing — and their condo association was not approved. One egregious example is a client who was the executor of his father’s estate. His Dad had died owning a condo unit. The family sunk thousands into fixing the unit up to sell, and then discovered the association was not FHA approved. Because of so many foreclosures and abandoned units, the association complained that they weren’t even sure they could gather a quorum for a meeting to seek FHA approval — and the financial health of the association would probably result in the FHA application being rejected. The client was forced to lower the price so cash buyers might be interested — selling for a price that was both well below market rates and failed to recoup the repair investment.

Why did the FHA ban spot loans in the first place? From 1996 to 2010, these kinds of loans were permitted in condo projects, but did not have adequate management, monitoring and quality control measures in place. Eric Boucher, an FHA condo approvals specialist with ReadySetLoan Condo Team LLC in South Windsor, Conn., says the inevitable result was that some developers and loan officers took advantage and obtained FHA-insured loans on units in projects that did not meet even minimal standards. Sometimes the loans were secured by structures that didn’t even qualify as legal dwelling units — for example, a motel in Florida that was converted to a condominium received FHA spot loans on every unit the building, even though not one had a kitchen.

But because FHA lacked the administrative capacity to carefully review and process loan package submissions and track spot loan endorsements project by project, the loans were all approved. In addition, the FHA recognized that many condo associations used concepts such as the right of first refusal and board approval of transfers to discriminate against potential buyers. When the FHA retooled its condo oversight in 2010, it instituted a much more rigorous certification process to identify eligible developments to prevent fraud, abuse, and discrimination, and totally banned spot loans.

The new certification process has plenty of controversy of its own, and thousands of condo boards have declined to apply. However, FHA officials claim they now have much better oversight and management controls in place. They also note that in any resumption of spot loans, much stricter standards would be in place for a unit to qualify, along with much more intensive monitoring. An attendee at a recent FHA-sponsored private roundtable for condo professionals quoted a senior official say saying that any new version “won’t be your father’s spot loan program.”

What does this mean? If spot loans are brought back, they certainly won’t be as easy to get as they were prior to 2010. Non-certified projects will probably get the same level of rigorous review that certified projects do. Approvals will be slow, and the costs will be higher. But to have this option back opens a door to condo owners, lenders, and real estate professionals that has been closed for years. And it may be the only hope for the revitalization of the condominium market in the metro Chicago area, especially the south suburbs.