In an effort to promote home ownership, the U.s. Department of Housing and Urban Development guarantees mortgage loans through the Federal Housing Administration. In addition to the principal and interest collected by lending institutions for conventional loans, borrowers pay an additional mortgage insurance premium to cover the government’s backing. Among the loan products insured by FHA, Section 203(k) loans are available to cover home improvement costs in purchase and refinance transactions. Because of the common property involved with condominium units, HUD imposes certain parameters on extending credit when these dwellings are the subject collateral.
Unlike other mortgages, when loan-to-value ratios are calculated by underwriters based on the property evaluation prior to closing, 203(k) loans are analyzed and approved based on the anticipated value when the repairs and improvements are completed. Condominium loan proceeds, therefore, must be confined to the unit’s interior – owned solely by the borrowers – and not affect the outer walls, which are maintained by the property association. The only permitted exception to this limitation is the installation of attic firewalls. As FHA will not assume the risk of improving an entire condo project, the agency is careful to restrict the number of units receiving 203(k) rehabilitation funds to five units or one-quarter of the total number of units in the project, whichever is less.
In keeping with its charter of helping those of modest means to own their own homes, FHA prohibits its 203(k) insurance from covering real estate investment properties. The aim is to assist the prospective owner-occupant, who would otherwise be without a home absent the loan. Non-profit entities, however, are eligible to apply if the proceeds are used to provide shelter to the underprivileged or disabled. Within the development, individual structures can not house more than four units after rehabilitation or they do not qualify under HUD rules. Townhome units – separated by a one and one-half hour firewall from the foundation to the roof – are treated individually, and are thus spared this cap.
The condominium project as a whole must be approved by HUD prior to the approval of a 203(k) loan. Borrowers must prove to lenders that the project is fully insured as to the integrity of the outer walls and structure. Liability insurance must meet coverage minimums and flood insurance – if necessary – must be documented. In short, HUD requires assurance that the homeowners association is meeting its obligations relative to the borrowers. This is necessary, since the condo fees are factored into the borrower’s monthly debt burden by mortgage underwriters. Condo associations, in turn, need to make the proper representations that those monies are spent as specified by their agreements with unit owners.
So many rules may strike homeowners as odd or capricious on the part of the government. For its part, though, HUD is protecting taxpayers from unacceptable losses by qualifying its beneficiaries and spreading the risk thinly. Like any reasonable insurer, the federal Housing Administration wants to receive as few claims as possible.