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FHA Condo Volume Up — But Is That Good?

by Peter G. Miller
May 19th, 2010

The latest numbers from HUD show a strong rise in FHA mortgage loans for condos. As of March, says HUD, 53,799 condo loans had been originated, up 35 percent from the same period a year earlier.

When it comes to mortgage activity we usually like to see “up” as better than “down” but in this case there’s some room for concern. Yes, FHA loans for condo buyers and owners have increased, but some portion of that increase is a result of rule changes — rule changes which also raise FHA risk.

Rule Changes

Let’s go back to 2009. HUD enacted several temporary rules which will continue through December 31, 2010. For instance:

___ The FHA concentration requirement defined was increased from 50 percent to 100 percent, meaning that every unit in a project could be financed with an FHA loan.

___ At least 50 percent of the units in a project must be owner-occupied or sold to owners who intend to occupy the units, according to HUD. However, “vacant or tenant-occupied real estate owned (REOs), including properties that are bank owned, may be excluded from the calculation of the required owner-occupancy percentage.”

___ In the case of new construction, the pre-sale requirement was reduced temporarily to 30 percent from 50 percent, meaning that a whole bunch of FHA loans are allowed even if a building is largely empty.

Risks

If you look at the temporary standards it’s obvious that south Florida, Las Vegas, California and other major condo centers will be major beneficiaries of the rule changes. It’s also obvious that there is a lot of risk in the temporary standards.

For instance, if a new project is 30 percent pre-sold is that enough to assure financial viability if only a few additional units are sold or the developer goes bankrupt?

Why not count bank owned condos? Will the lender-owners of such foreclosed properties pay their monthly condo fees? Property taxes? Note that lenders will sometimes foreclose on a property but not take title, so the defaulting owner remains liable for taxes and condo fees. That’s great from a legal technicality sense but it doesn’t do much for the underlying economics of a condo project.

Is it really a good idea to have one lender or loan insurance plan for an entire condo project? Would it not be smarter to spread the risk by limiting FHA loan loans to, say 75 percent of the units with a given property?

The result of the temporary HUD rules is that a lot of risk has been shifted from condo developers and lenders to the FHA mortgage program. That may help stimulate sales in given communities — and some of those communities need all the help they can get — but a few years down the road will the FHA reserves be hit with massive claims? Hopefully in a few years the major condo markets will have recovered and the FHA program will see a reduction in claims, but who knows what will happen.

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