Dan Hartman

I’m going to open this up this article with a shocking revelation:

Condominiums are not the same as single-family homes.

Lenders do not view condominiums in the same way as single-family homes. There are additional risks that are considered, additional documentation that must be obtained, the result of which is that purchasing a condominium can be tougher than it seems. Let’s take a look at a few factors that are considered in evaluating condominium mortgages, and at the 5 ways that condos can be approved for conventional financing.

Completion

Banks are most concerned with the aspects of a condominium that can impair the future value and marketability of the property. A condo unit in a complex can be only as valuable as the complex as a whole. As a result, banks want to know about the degree of completion. Specifically, it is important to know if construction of all units in the complex or phase is completed.

Banks will also ask if all common elements are completed. Why? As a unit owner, you will hold title to 1.17% (or whatever percentage it is) of all common elements in the development. If the common elements are not completed, the property is worth less than might be expected. Likewise, if one or more units are not completed, the value of other units can be hurt. For a bank, the worst case scenario is that pending units remain uncompleted, reducing the number of units paying association dues. Also, as we are seeing with foreclosed homes, unoccupied, non-completed properties are a blight on all those around them, and have an adverse affect on value.

Occupancy and Ownership

Another question banks will ask about a condominium development regards occupancy and ownership. What does this mean? History and research have shown that mortgages on properties occupied by their owners are less likely to default. Similarly, condo complexes occupied by unit owners will tend to be better investments for lenders, as people tend to take care of their homes.

To account for this, banks will ask what percentage of the units are owner occupied, looking for a 51% or higher ratio for approval. Unsold units in a new development will be considered non-owner occupied for this calculation, which makes financing more difficult for the first half of such units.

Ownership is also a major consideration, as concerns arise when a development has a small number of owners holding a large number of units. This can be a concern, as one or two owners holding a significant proportion of the units could block capital improvement projects in the future, potentially risking the value of the complex.

Specifically, banks will want to know if any one entity owns more than 10% of the units, and will typically avoid financing such a complex. The one exception to this rule is new developments, where the developer is typically exempted on all previously unoccupied units.

Other Factors

Banks are also concerned with several other aspects of the condominium’s administration. The association board is typically controlled by members of the association, however, newer complexes are often administered by the developer until a sufficient number are sold. Banks will ask about who controls the association, however this is typically not a problem so long as a plan is in place to transfer control of the association to the unit owners, and the association is sufficiently capitalized.

A popular method of building new-built condominiums is in phases. Phasing permits a developer to build little by little, reducing the capital requirements of a large project. This can be very beneficial to the builder, as it helps to maintain liquidity, and reduces carrying cost for unsold units. In some cases it can present problems for lenders, especially if upcoming phases include common.

We’ve reviewed the significant factors that are a part of the condo approval process. For a breakdown of the 5 available methods of obtaining condo approval, please continue to part II.

Condo photos courtesy of Jim Dusty of Gordon Appraisal, used by permission.

Earlier this week, I recapped the market phenomenon referred to as a "Flight to Safety". In such a situation, investors flee riskier investments, in favor of assets that are more secure, such as oil, treasury bills, and gold.

What happened today is clearly such a Flight to Safety.

As you know, the Federal Reserve announced yesterday it would lend $85 Billion to help stabilize troubled insurer American International Group, a company that insures homes, cars, businesses, and mortgages, among other things, while investing its assets in stocks, bonds, mortgages, and other investments. This loan came with a very high price: 11.5% interest on the lent funds, and the possibility of a nearly 80% equity stake in the company. At today's closing price of $2.05 per share, that 80% stake is worth a paltry $3.87 Billion.

A good investment? At the 22:1 payoff that is needed for the equity part of that equation to work, there's another term for that:

BET.

On a roulette table, there is only one bet that pays out greater than 22:1, and that is playing just a single number. Of course, the government isn't just betting on the likelihood of its equity stake paying off, rather, it made the loan because it feels there is a reasonable chance that AIG will be able to repay the loan, with interest, and, at current rates, assuming the Fed is vindicated, there will be a tidy payoff. If the Fed can borrow the $85 Billion at current market rates around 3.4% for government borrowing, it will make about $13.7 Billion in net interest income over the 2 year term of the loan. If the Fed is wrong, guess who will be holding the bag on that $85 Billion.

If you guessed us, you are correct.

Wall Street thought about this possibility today, and decided it didn't like that outcome at all. Sharp selling ensued, leading to a greater than 4% decline in all major indices.

Remember, when investors sell one class of assets, for today, stocks, they typically buy another. Today saw investors aggressively buying crude oil, pushing its price up about 7% to just over $97 per barrel. Gold saw its largest one-day increase EVER, increasing by $70 on the day, nearly a 10% increase.

The big story of the day was on the money market where short-term investments maturing in less than one year saw huge trading volume, and a price surge that caused their yields to drop near zero. At Tuesday's close, the 3-month treasury bill was priced to yield 0.64%. By day's end today, its yield stood at 0.01%, a decline 63 basis points. The 6-month treasury fared even worse, dropping 74 basis points in yield to close at 0.69%. Essentially, this means that investors are willing to sacrifice all possibility of return on their investments just to have a chance at those investments holding value.

Of course, when stocks are down 4% today, and nearly 8% since Friday, just holding value doesn't seem so bad, does it?

Mortgage rates may see some benefit from recent events in the future, but at present, all mortgages are viewed as risky investments, and as a result, the lower demand for risky investments has pushed up mortgages slightly this week. At 2006 risk levels, 30-year fixed rates should be approaching 5% right now. Instead, they are hovering just under 6%. Hopefully this government intervention will help to build a foundation under the market.

Please check back Friday for an update on the Mortgage-Treasury Spread!

I've been hearing a lot more about the USDA Guaranteed Rural Housing mortgage program lately. I've been seeing a significant increase in buyer interest in this program, too. With the current, (albeit, likely temporary) suspension of seller-funded down payment assistance programs, the USDA GRH program is ideal both for sellers and buyers. Here are just a few of the opportunities presented by this program:

1. Same great rates as FHA mortgage - FHA loans are currently pricing around 6.0% and edging lower. We can offer the same rate on USDA GRH loans.
2. 100% financing, 102% financing, even more! - USDA always allows financing of the full purchase price of the home, plus the 2% USDA guarantee fee. If the home appraises higher, additional money can be financed for closing costs, appliances, even home improvements!
3. No monthly mortgage insurance - FHA loans require buyers to pay monthly mortgage insurance for a minimum of 5 years. USDA doesn't.
4. Simple qualifications - Got reasonable credit, decent but not excessive income, and you're shopping in an appropriate price range? You're probably going to qualify for USDA.
5. Government backed - If you're worried about all the problems with exotic mortgages, there is on such need to worry with the government guaranteed USDA program.
6. Broad definition of "rural" - I know many people have dismissed this program in the past due to the perception it doesn't cover most communities. In Rhode Island, it covers about 75% of the state's area, including parts of Cranston, Johnston, Smithfield, and other communities that you might not have considered rural.
7. Income exceptions are available - Yes, the USDA mortgage does turn away high-earning families, but for those close to the limit, income adjustments can be made to account for expenses such as childcare, medical bills, and more.

Clearly, the USDA mortgage is the program to consider for buyers seeking a single-family home in an eligible area. For more information on how best to use this in marketing those homes, check back later today! If you have additional questions about the Rural Development program, please contact me directly, or leave a comment here.

If there is rock & roll playing in lower Manhattan this morning, it is probably The Doors' "Peace Frog", as investors awoke to a market seeing financial giants Lehman Brothers, Merrill Lynch, and American International Group all discussed in badly negative news.

Lehman, a troubled investment firm with major investments in the mortgage market filed for Chapter 11 Bankruptcy this morning. Its stock has declined from over $65 at the beginning of 2008 to less than a quarter this morning. The company had sought government intervention or an outside buyer over the past 10 days, but when none was forthcoming, found itself without options.

Merrill Lynch, once one of the "Big 5" investment houses, had also suffered huge losses this year, although its involvement in the mortgage market was not as direct as Lehman's. After its stock had tumbled nearly 70% year-to-date, Bank of America agreed to purchase the troubled firm for a similar 70% premium over its $17.05 closing price Friday.

American International Group, or AIG, also faced serious questions this morning, seeing its stock tumble more than 50% as it became apparent that the company would need additional funding to continue operations.

All three of these events have had a profound effect on credit markets. Because of perceived risk in financial stocks, there has been a huge Flight-to-Quality this morning, as investors have abandoned riskier stock-market investments, instead piling into secure investments, especially government bonds.

A Flight-to-Quality is an event in which investors abandon riskier investments in favor of more secure investments. US Treasury debt, backed by the full faith and credit of the United States Government, is very secure, and is typically the most actively traded and widely sought investment in the instance of a Flight-to-Quality. As a result, today saw treasury bond prices increase sharply, lowering the 10-year yield from Friday's close at 3.72% to 3.52% in mid-day trading. A Flight-to-Quality is often erroneously referred to as a Flight to Safety.

Mortgage rates were not as significantly affected, due to the added risk of investment in mortgages. Additional speculation suggested that the Federal Reserve Open Market Committee, scheduled to meet tomorrow, might consider cutting interest rates further to stabilize markets. We'll find out about that tomorrow afternoon. For additional information regarding the relationship between mortgage and treasury rates, see this article, or check back Friday for an update.

Well, it's official. I got an email this morning from our last wholesaler that was offering to fund loans using seller-funded down payment assistance programs like Nehemiah or Ameridream, stating that they were going to stop accepting new registrations for loans using these programs.

So, this means no more 100% financing, right?

Well, not exactly.

According to the Wall Street Journal on Wednesday, several members of Congress, including Financial Services Committee Chair Barney Frank, are pushing legislation that would restore the status of seller-funded down payment assistance programs such as Nehemiah and Ameridream. The legislation would, however, place significant restrictions on who could use that money.

Specifically, credit and risk would play a major part in that. Because loans using down payment assistance have historically defaulted at much higher rates than loans where buyers supplied their own down payment funds, Congress moved in August to prohibit use of such programs. Research had shown that as many as one quarter of all loans with seller-funded assistance were defaulting, putting s major strain on HUD's FHA insurance fund.

On further review, though, it was found that these defaults were concentrated among those homeowners with lower credit scores. Currently proposed legislation would reinstate down payment assistance for buyers with 680 or higher credit scores without restriction, and would allow buyers with scores of at least 620 to purchase, albeit potentially facing higher FHA insurance premiums. These higher premiums would fund the higher probability of default brought by those buyers.

In the meantime, there are other options still available to buyers unable or unwilling to make the 3.5% down payment FHA mortgages will require as of October 1^st. Specifically, USDA and VA mortgages continue to be attractive options for qualified buyers. Please check back later this week for more information on these options.