The Federal Housing Administration (“FHA”) is a government-owned and operated insurance company which was established by the National Housing Act of 1934. FHA insures home loans for buyers who typically cannot afford a conventional down payment. To be clear, FHA does not lend taxpayer money and is not the originator of mortgage loans. Thus, a ‘FHA backed loan’ provides a home buyer, including the purchaser of a condominium unit, the ability to purchase the unit with a small down payment and, most often, at a lower interest rate—a purchaser can put as little as 3.5% down as opposed to the normal 20% down required by most conventional mortgages. Given the recent economic downturn, many condominiums have observed less buyers, more delinquencies, a spike in foreclosures and the rise of investors buying multiple units in the same condominium for lease or sale. These circumstances quickly change the nature of a condominium from a ‘neighborly owner community’ to an ‘investment community’. In 2009 and 2012, FHA instituted significant reforms to the condominium certification process. This article addresses the basics of FHA certification, the preliminary documents necessary to determine eligibility, common issues which affect eligibility and the benefits of FHA certification.
What is FHA Certification?
FHA certification is a process which confirms that a condominium association meets specific FHA legal, financial and other technical requirements. Simply, a condominium buyer cannot use a FHA-backed mortgage to purchase a condominium unit unless the condominium association is already FHA certified. The FHA certification is valid for two years and a condominium association may begin the recertification process up to six months prior to the expiration date. The United States Department of Housing and Urban Development (“HUD”) webpage allows users to search for FHA-approved condominium projects by state, county, name or status. The website is available at https://entp.hud.gov/idapp/html/condlook.cfm.
Basic Documents Required Before Determining Whether Your Condominium is FHA Eligible
In order to ascertain whether a condominium is eligible for FHA Certification, it is important to obtain and review specific legal, financial and insurance documents. First, the Board of Directors should obtain a copy of the Articles of Incorporation, the Master Deed and the Bylaws. In Michigan, the Articles of Incorporation are available to the general public at http://www.dleg.state.mi.us/bcs_corp/sr_corp.asp. The Master Deed and Bylaws are recorded in the Register of Deeds’ Office in the county in which the condominium is located, however most condominium associations and property managers maintain copies, if needed. Included with the Master Deed and Bylaws should be the recorded plat map with the legal description of the project and any condominium site plans.
Second, the Board of Directors should gather the association’s financial records, including any audits performed in the last year, a recent balance sheet and the current budget information.
Third, the Board of Directors should compile copies of any insurance policies, especially the declaration page(s) for the blanket insurance, liability insurance, fidelity insurance and/or flood insurance.
Finally, the Board of Directors should gather any additional documents such as the executed Management Company Agreement, if applicable, and a copy of the owner directory/addresses. These documents are crucial to determining if your condominium is eligible for FHA certification. Often times, a preliminary review of these documents will determine if a condominium is ineligible for FHA certification.
Basic Eligibility Requirements
FHA has specific requirements to obtain certification that may cause issues for certain condominiums in Michigan. Recently, FHA enacted new rules which went into effect on September 13, 2012 which has made it more difficult to obtain FHA certification. Without listing all of the eligibility requirements, a few highlights of the most common issues include:
- All units, facilities and phases of the project must be complete.
- At least 50% of the total units must be sold.
- No more than 15% of the units can be delinquent (not including late fees or other administrative expenses) for more than 60 days. The 15% threshold includes all units whether occupied, unoccupied, bank-owned or those owned by an investor.
- 50% of the project must be ‘owner occupied’ (FHA will not certify a condominium association where more than 50% of the units in the project are owned by a single entity).
- At least 10% of the budget must go towards reserve funding.
- No more than 50% of the condominium can be used as commercial space.
- FHA will not certify a condominium project where the agency already insures more than 50% of the mortgages in the condominium.
- The condominium’s blanket insurance must cover 100% of the replacement cost of the condominium, not including the foundation or land.
- The condominium’s general liability insurance must insure all of the common elements and public ways.
- Flood insurance is required if within a 100 year flood plain.
- A fidelity bond is required for condominiums with 20 or more units.
Even if a condominium does not presently meet the requirements, there are steps that every condominium may take to become eligible. For example, the association may wish to enact and uniformly enforce a collection policy as part of its Rules and Regulations to reduce any delinquencies. As another example, an association may wish to amend its Bylaws to cap the number of non-owner occupied units to 50%. Given that amending Bylaws requires 2/3 co-owner approval, associations must be proactive in making sure the Bylaws address this issue well before the 50% range. If your association has 15-20% investors, our office recommends addressing this issue as soon as possible. As a final example, any insurance issues which arise are often easily resolved with the involvement of competent, professional insurance providers familiar with condominiums.
The Benefits of FHA Certification
A common misconception regarding FHA certification is that it allows ‘poor people’ into wealthier communities, thereby ‘bringing down the value of the neighborhood.’ Simply, this myth is false and, quite the contrary, FHA certification is beneficial for numerous reasons. First, FHA certification provides a larger pool of prospective condominium buyers which, in turn, increases the value and marketability of all of the units in the condominium. In late 2014, FHA announced that the loan limit beginning January 1, 2015 for high cost” areas is $625,500 and the loan limit for “low cost” areas is $271,050 (Note: these numbers have been reduced from prior years). While the actual loan amounts are determined by property value, borrower age and current interest rates, these maximum loan amounts are certainly not just for ‘poor people’. As of 2010, the Government Accountability Office (“GAO”) issued a report indicating that 40% of all home purchase mortgages were insured by FHA. A copy of the report is located at http://www.gao.gov/products/GAO-12-15. Given the tightening of FHA’s requirements, 40% may be the peak of FHA backed loans, but FHA insured loans still represents a sizeable number of potential buyers in the marketplace.
Second, FHA certification increases the likelihood to maintain a ‘neighborly owner community’ instead of an ‘investor community’. Given that FHA only insures mortgages that are used to purchase a primary residence, the ‘investor issue’ which many condominiums are experiencing is diminished or eliminated.
Third, a recent case in Ohio is indicative of problems which may arise if a condominium association does not attempt to obtain FHA certification. The Ohio Civil Rights Commission filed a discrimination lawsuit against an association for not obtaining FHA certification. In that case, a single mother with one child attempted to purchase a condominium unit in a community that was previously FHA-certified. The association made the decision not to seek FHA re-certification and the mother’s loan failed. The Commission filed suit saying that the failure to seek re-certification resulted in potential discrimination due to the child. While the outcome of this case is yet to be determined, condominium associations would be wise to avoid any potential claims of discrimination that could be costly and poor publicity to the condominium association.
How to Become FHA Certified
There are two methods for a condominium association to become FHA certified. First, a FHA-approved lender may submit a condominium association for approval through the Direct Endorsement Lender Review and Approval Process (“DELRAP”). Under this process, the association works with a FHA-approved lender to obtain certification. Second, a condominium association can hire legal or professional counsel through the HUD Review and Approval Process (“HRAP”). Under this approach, the condominium association, typically through its attorney, submits the necessary documentation and application to FHA. The attorney is there to guide the association through the process and ensure that any issues which arise are resolved quickly and efficiently. Regardless of the method utilized by the condominium association, the criterion for FHA certification remains the same.
Given the benefits of FHA certification, each condominium in Michigan should consider whether it is eligible for FHA certification and, if not, what steps the condominium association should take to become eligible for certification. Having competent legal representation review your condominium association’s legal, financial and insurance documents is an important first step to determine if the condominium association is eligible for FHA certification or what steps may be necessary to obtain FHA certification.
The team at Hirzel Law, PLC is composed of award-winning real estate attorneys that can offer quality representation for Michigan clients. Regardless of if you are a commercial real estate developer or individual homeowner, our real estate attorneys can help. We fully understand how unique and complex the challenges that our clients may face, and our real estate attorneys are prepared to help in whatever way necessary. Contact Hirzel Law online or call 248-986-2921 (Farmington) or 231-486-5600 (Traverse City) or 616-319-9964 (Grand Rapids) to learn how our Michigan real estate lawyers can help protect your Michigan real estate investment today.