Importance of 10% Reserve Contribution to Condo Unit Financing
If you know anything about FHA condominium project approvals, you know that it requires that associations annually contribute 10% of its budget to a reserve fund. This account must be held separately from the operating account. But did you know that Fannie Mae has the same requirement?
In speaking with several associations recently, I was surprised to hear that they knew about this FHA requirement but didn’t know anything about Fannie Mae. “We aren’t seeking FHA approval” was the response from one condo board member. Maybe not, but you are ruling out the VAST majority of buyers by not making this contribution.
Unlike FHA, Fannie Mae does not require project approval in order to allow the financing of units in a condominium project. However, when the loan is underwritten by the lender, the project is scrutinized, albeit to a lesser degree. Investor concentration, insurance and finances are a few components investigated by the lender to determine the project’s acceptability.
Fannie Mae has two levels of project approval when it underwrites loans: Full Review and Limited Review. The Full Review was mentioned in the previous paragraph. For a Limited Review, only the borrower’s qualifications are reviewed; the finances of the association are not reviewed.
To be granted a Limited Review, the borrower must make a 20% down payment for an owner-occupied purchase or 25% for a second-home purchase. Limited Reviews are not available to investors. Fannie Mae’s automated underwriting system must state that the loan qualifies for a Limited Review. Otherwise, it must go through a Full Review.
If the association is not maintaining a reserve account nor contributing 10% to it annually, unit financing will be denied to any borrower who doesn’t qualify for a Limited Review.
Condominium buyers are typically first-time buyers, divorcees, retirees and investors. What percentage from the first two groups are buying a unit with 20% down? I don’t have the exact figure, but we can all estimate it to be a very low percentage. FHA loans, alone, are roughly 40% of the market. How will the Law of Supply and Demand affect the values of the units in the community?
One condominium in Manchester, CT, for example, has not and will not contribute or maintain a capital reserve account. There hasn’t been a sale in the community since 2008.
When discussing reserve accounts, please keep in mind that it doesn’t just affect FHA financing options. Not making the proper contribution may not only be problematic when future capital projects are required, it may also make the financing of units nearly improbable.
Image courtesy of keerati/freedigitalphotos.net
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