How to Buy a Non-Warrantable Condo
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If you’re condo hunting and you live in a competitive area, you’ve likely encountered a non warrantable condo in your search. But just what does that mean, and is it really that important? Should you walk away or figure it out because you’ve found a diamond in the rough?
The answer to all of those questions is… it depends, and for a variety of reasons as you’ll soon see.
What is a non-warrantable condo?
A non-warrantable condo is a condo that does not meet the criteria established by Fannie and Freddie. Because of this, neither Fannie or Freddie will buy the loan from the buyer’s lender after it’s been issued.
Who is Fannie and Freddie?
Fannie Mae (Federal National Mortgage Association or FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation or FHLMC) are the corporations responsible for the rules and regulations that apply for getting a conventional loan.
Originally chartered by congress to stabilize and encourage the housing market, one of their ongoing responsibilities is to formulate rules that protect both borrowers and lenders during a real estate purchase.
As frustrating as they may be, the rules behind buying condos are meant to protect everyone involved.
What makes a condo non-warrantable?
There are a lot of reasons a condo could be classified as non-warrantable, but some reasons occur more than others.
Most condo shoppers denied a loan are usually denied for either one of the following five reasons:
A Single Investor Owns More Than 10% of the Units
If an investor, including the initial developer, owns more than 10% of the units within a condominium, that condo will be considered non-warrantable by Fannie Mae and Freddie Mac.
The reason for this is to protect the borrower.
Imagine the following scenario: A developer owns 20-30% of the building. One of his other projects doesn’t fully sell and forces him to file chapter 11. His lender then stops paying all of the dues on the building, which in turn affects the entire building’s financials. When that happens, the management puts what is called an assessment on each shareholder (aka condo owner). That assessment raises the common charges to as much as 200- 300%, which in turn would likely cause most borrowers to be late on their mortgages.
It’s because this rule wasn’t in place that a lot of people went into foreclosure during the 2008 crash.
15% Delinquency on Homeowners Association Fees
Condos come with HOA fees. HOA fees cover the costs of maintaining and repairing the condominium itself. This includes such things as swimming pools, elevators, outdoor patios, general landscaping and lobbies. HOA fees are also collected to cover expected future expenses, such as new roofs or elevator repairs.
When 15% of condo owners don’t pay HOA fees, lenders consider any condos for sale within the condominium unwarrantable. Should an emergency happen, the HOA will not be able to cover the cost of repairs and will have to raise HOA fees overnight. If raised high enough, many condo owners will not be able to pay their mortgages.
It’s a risky situation to be in for both condo owners and lenders, and is why Fannie and Freddie have made it an ‘unwarrantable offense.’
HOA is Involved in Litigations
The third likeliest reason a condo could be non-warrantable, is that the condo is involved in a litigation or lawsuit. Regardless of what side the condominium is on (plaintiff or defendant), any condo for sale within the property is unwarrantable.
Common reasons condos are involved in litigations usually revolve around building defects (where the HOA is suing the original construction company for cutting corners) or condo owners are suing each other or management.
Lenders don’t like to see this because it places the whole condominium at risk for a variety of reasons. Most of those reasons point back to increased HOA fees.
50% and Above Investor Ratio
When 50% of the condos within a condominium are non-owner occupied (meaning they’re investor units), it poses a risk to the lender. One of the reasons behind this is that lenders assume investors are not going to care for the condominium the same way as someone who actually lives there.
Investors always look at their ‘return of investment’ when making spending decisions. Are they going to take the high road and repair something the way it needs to be repaired? Oftentimes the answer is no. Typically, they make their financial decisions around short term goals, which in turn can affect the overall health of a condominium.
35% and Above Commercial Space
The reasoning behind this is simple: if the business fails, it affects the financial health of the condominium overall. If the condominium relies on a business for income, if and when it fails or moves, the HOA’s financials are going to suffer. When that happens, the monetary burden is placed on the individual condo owners with increased HOA fees. As with the above reasons, an increase in HOA fees would possibly result in borrowers unable to pay their monthly mortgage payments.
Other Reasons a Condo Can Be Deemed Non-Warrantable
Below are more reasons a condo would be considered unwarrantable by lenders. These do not happen nearly as frequently as the reasons discussed above, but you should be aware of them nonetheless.
Borrower or buyer will have restricted access because the unit is part of a co-op or time-share
Unit comes with mandatory fees from a third party that are well outside of HOA fees
Unit has been subdivided by the seller who only has one mortgage and deed
Some individual condo units generate money through motel models
Condo is near a dump, landfill, major road, airport, or military base
Condo unit is registered with the SEC as an investment opportunity
Developer offers financing concessions that are not allowed by HUD
Parts of condominium also act as assisted living centers
HOA runs a non-incidental business
Condominium does not have proper insurance coverage to cover an emergency
Many sections of the condominium are not structurally complete
Can an FHA loan be used to purchase a condo?
In order to get an FHA loan for a condo, the condominium itself must be approved by the FHA. Which condominiums have been approved by the FHA vary area to area. This is because FHA approval is a lengthy process for developers and costs them a lot of time and money. Many developers choose not to do it at all— which in turn essentially forces buyers to get a conventional loan.
In order for the condominium to be FHA approved it must meet certain criteria.
Note: You’ll notice that the criteria are very similar to the criteria established by Fannie and Freddie, but they are different:
The HOA must not be involved in any major lawsuit
Condominium must be well away from active roads, railroads, military bases and airports
50% or more of the condo units must be owner-occupied
‘Right of first refusal’ must not violate the Fair Housing Act
No single person or entity may own more than 10% of the units in a condominium
Must not double as a ‘condotel’
Only 15% or fewer of the units may be behind on HOA fees
Must have an adequate amount of capital reserves
Condominium must be substantially complete
Condominium must have an adequate amount of insurance coverage
Commercial space can only account for 25% or less of the condominium’s total square footage
For more information on FHA approval for condos, go here.
Recent Fannie and Freddie Updates for Conventional Loans
If you can’t get an FHA loan, a conventional loan may be the next best choice. Luckily, Fannie and Freddie have introduced new rules for condo purchases that make them a little easier to buy.
Recent changes include:
Commercial space allowance has gone up from 25% to 35%
Litigations that are minor and unlikely to affect the stability of the condominium will be ignored
Smaller condominiums (with only 2-4 units) have more relaxed standards to meet (in regards to commercial space, single investor ratio, HOA fee delinquency, etc.)
All of these have the potential to make many condos warrantable that would have previously been non warrantable.
How do you get financing for an unwarrantable condo?
Option 1: Find a portfolio lender
A portfolio lender is a lender that does not sell the loan after it has been issued. Instead, this type of lender keeps the borrower’s debt so it can earn interest on the amount loaned.
You’ll find that many smaller banks and credit unions are portfolio lenders who specialize in issuing non-conforming mortgages that are neither insured by the federal government or bought by Fannie and Freddie.
Just know that each portfolio lender has its own basic criteria for borrower’s to meet, but these criteria can change depending on the risk associated with the loan and the intended purchase. For more information, you’re going to have to contact portfolio lenders individually.
Option 2: Ask for seller financing
Seller financing is when the seller loans the amount needed to purchase his or her real estate. This isn’t common when purchasing condos, but it is possible.
Option 3: Ask the Condominium to Apply for FHA Approval
Honestly, this is a long shot, but it has been successfully done in the past.
It’s in the HOA’s best interest to do this in the long run because it almost guarantees that the condominium will have high occupancy rates. The more units that are filled, the more financially stable the HOA has the potential to be.
But remember: it costs money to get FHA approved, which is money the HOA may very well not have. Also keep in mind that most condo loans are conventional loans these days. If you want to buy in a competitive area, where units are only on the market for 60 days or less, the likelihood of the HOA fulfilling your request is small because it knows someone else may not have an issue getting a loan.
What to expect when buying an unwarrantable condo?
Loan terms will vary depending on the reason the condo is non warrantable. Unfortunately, loan managers are unwilling to give ballpark figures. That said, you can expect:
Higher Rates
You will likely pay a higher rate than you would if you had been eligible for a conventional or FHA loan.
However, if you take into account how much you pay when you rent, the higher rates from a portfolio lender will likely still seem pretty cheap when you take into account equity and condo appreciation.
Don’t forget that other things contribute to your interest rate. These include:
Gross Monthly Income
Credit Score
Loan Amount
Down Payment
Larger Down Payment
As with higher rates, the down payment you’ll be expected to make may be significantly higher than what you’d pay with a conventional loan. The amount will vary depending on the risk associated with the loan. A 25% down payment is not out of the question.
Why should you consider moving on?
You love the condo, but how much? Would walking away put you in a stronger financial position? Never buy real estate that would put you in financial instability or financial uncertainty. If you’re not better offer after your real estate purchase, then you bought the wrong home!
Also consider that:
Warrantable condos come with lower rates.
A warrantable condo will allow you to use a conventional loan, which in turn means your loan will have a lower interest rate. Depending on the condo and the loan amount, this could be a lot.
Still, a high interest rate is often better than renting.
Townhomes don’t have as many hoops to jump through.
Townhomes don’t have a whole list of criteria they have to meet. They’re basically the same as purchasing a regular home.
If you’re having trouble finding a condo, consider altering your search to incorporate townhomes.
It might be hard to sell.
Know it’s not going to be your forever home? It might be just as hard for someone else to buy it from you in the not-so-distant future.
Any number of other reasons.
The reasons are many, which is why many banks simply say no. For example, delinquency on HOA fees could spell complete disaster for the condominium overall. The right push in the right direction could cause it to financially collapse in less than a year.
It's up to you to make the call.
Buying a non-warrantable condo can be done, but whether it should be done depends on the condition, the situations and the circumstances surrounding the reason (or reasons) for why it has been deemed non-warrantable.
Carefully consider all of the whys, and look at the long term effects it will likely have on your finances. If the risks are small and you can comfortably make the down payment, then the condo might worth the extra hoops. If the risks are many and your return on investment is questionable, then maybe you should let someone else take that risk.