FHA Condo Approvals - Budgets

FHA Condo Approvals – Budgets

HUD released new guidance regarding budgets when it issued Mortgagee Letter ML11-22.  Prior to this, the review of the budget was somewhat subjective in nature.

I wanted to write about budget guidelines as it pertains to FHA condo approvals because HUD noted that more condominium projects are being Rejected due to budget issues than for any other reason.  If projects understand what it is that HUD is looking for, it will alleviate a lot of the stress and make it easier for projects to get approved or recertified.

HUD looks at the financial viability of the project as a whole but investigates a few areas specifically.

10% Contribution to Reserves

HUD requires that there be a line item in the budget whereby 10% of the budget is contributed to a separate reserve account which is to be maintained for future capital improvements and maintenance costs.  The 10% is calculated by taking 10% of the annual collected unit owners’ monthly dues/assessments.  Money collected for late fees, clubhouse fees and/or interest income are excluded from this calculation.

Prior to the release of ML11-22, this requirement was loosely adhered to.  I had worked with several condominium projects that were approved without the budget containing a 10% contribution to the reserve account but this is no longer acceptable.  In those cases, the reserve account contained far more funds than HUD requires, which is a nice lead-in to the next section.

Reserve Account Equal to at Least 10% of the Budget

HUD requires that the condominium project maintain a reserve account for future maintenance and capital improvement projects equal to at least 10% of the annual budget.  This is separate from the previous section.  This means that not only does the budget need to contain a line item for contribution to reserves but the project must also maintain a reserve account of at least 10% of the annual budget.

In some cases, it is not enough to have only 10% of the budget in reserves, especially for older projects that may need capital improvement projects in the near future.

Balance Sheet

HUD requests a copy of the balance sheet dated within the past 90 days to gain an overall sense of the financial stability of the project.

Previous Year-End Income and Expense Statement

HUD also reviews the previous year’s Income and Expense Statement to determine if the budget for the previous year was properly developed and compares it to the current year’s budget.  This gives HUD a better sense of how the HOA manages its funds from year to year.

Special Assessments

This is technically a realm aside from the budget but it is something that HUD looks at to determine the financial strength of the project.  If a project must continually fund capital improvement projects with special assessments, then this could point to financial stress of the project as a whole, especially if used to fund the reserve account as mentioned above.

Special assessments, in general, are regularly accepted by HUD so please don’t understand this section to infer that if your project has a pending special assessment that it cannot be approved with HUD.  I have helped many projects gain approval or to be recertified who have special assessments.

Loans

If the HOA has taken out loans, this is not immediate grounds for rejection.  HUD will want more information regarding the purpose of loan and will look at it from a global perspective.  As with special assessments, above, if the HOA acquired the loan as a means to keep the project financially viable, there could be a problem.

However, if the loan was taken out to replenish a depleted reserve account that was used to make repairs from some unforeseen catastrophe, then this may not affect the project’s approvability with HUD.

Insurance

The condo processing Guide states that the budget must “provide adequate funding for insurance coverage and deductibles.”  HUD admits that it’s not necessarily the budget that must provide for coverage of the deductibles, but that the entire financial picture must show that if there is a need for an insurance claim, there must be enough funding to cover the cost of the deductible.  This can be evidenced from the budget or from the reserve account, providing, of course, that it does not deplete the reserve account.

Reserve Study

If it is determined that the budget and financial strength of the project does not meet the above standards, a reserve study must be completed by a third party engineering firm.  The cost of such a study falls on the Association.

A reserve study examines the structural aptitude of the project and investigates items such as the roof, siding, decks, pool and other structural components of the project.  It then determines how much these items will cost the project should they need to be replaced and when they would need to be replaced.  As a result, the reserve study would provide the project with accurate details as to how much should be in the reserve account and how much the annual contribution to the account should be. 

If you have questions about your condominium project’s financial stability as it pertains to gaining or recertifying an FHA condo approval, it would greatly benefit you to have an expert investigate the above-mentioned items.

Photo courtesy of Graeme Weatherston