The Intricacies of Non-Warrantable Condominiums: A Comprehensive Guide
The real estate market is a complex labyrinth of opportunities, and condominiums represent a unique segment of this market. They offer the advantages of homeownership without the burdens of maintaining a single-family home. However, the path to condo ownership is not without its hurdles. One such challenge is the concept of non-warrantable condos. This article delves into the intricacies of non-warrantable condos, providing a comprehensive guide for prospective homeowners.
Unraveling the Concept of Non-Warrantable Condos
A non-warrantable condo is a condominium unit that does not meet the standards established by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. These GSEs play a pivotal role in maintaining the stability of the housing market by purchasing mortgage loans in bulk and repackaging them as mortgage-backed securities for sale on the secondary mortgage market. This process allows lenders to issue more loans without retaining the debt on their books.
However, the GSEs have stringent standards designed to mitigate potential risks that could make the debt more precarious for third-party investors. When a condo does not meet these standards, it is classified as non-warrantable, indicating a higher risk for the lender. As most lenders depend on their mortgage debt being guaranteed by the GSEs and purchased by investors, securing traditional financing for a non-warrantable condo can be challenging.
Distinguishing Between Warrantable and Non-Warrantable Condos
The distinction between warrantable and non-warrantable condos lies not in the physical structure or condition of the unit, but in the risk factors associated with the property. A non-warrantable condo is one where the development or Homeowners Association (HOA) has an issue that Fannie Mae and Freddie Mac consider particularly risky. This riskiness may necessitate alternative financing methods for prospective buyers.
The Factors That Render a Condo Non-Warrantable
Several conditions can render a condo non-warrantable, according to Fannie Mae and Freddie Mac. These include incomplete construction of the development, commercial use of more than 25% of the building, a majority of units rented to non-owners, litigation involving the HOA, ownership of more than 10% of the units in the building by one individual, and delinquency on association dues by more than 15% of homeowners.
Each of these conditions is a red flag to lenders and the GSEs, indicating increased risk associated with financing a unit in the development. Consequently, the GSEs are reluctant to guarantee such properties, leading to fewer lenders willing to assume the added risk. However, this does not necessarily mean that a non-warrantable property is a poor investment or unsuitable as a home. It simply means that prospective buyers may need to explore creative financing options.
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Securing Financing for Non-Warrantable Condos
While obtaining financing for a non-warrantable condo can be more challenging, it is not impossible. Small local banks, which often retain their mortgages rather than selling them on the secondary mortgage market, may be less concerned with GSE approval.
Engaging a realtor or mortgage broker with experience in non-warrantable condos can also be beneficial. They can provide insights into the warrantability of the building and direct you to lenders willing to provide a mortgage. Several reputable lenders offer non-warrantable condo loans, including Northpointe Bank, Mortgage Depot, First National Bank of America, Fidelity, Blue Water Mortgage, North Star Funding, and First Heritage Mortgage.
The Implications of Buying a Non-Warrantable Condo
Purchasing a non-warrantable condo is a viable option, provided you are aware of the associated risks. A non-warrantable status does not necessarily indicate a bad investment. In fact, you may secure a better deal on the price, as developers and sellers are aware of the financing challenges. However, it is crucial to understand why the condo is non-warrantable and how it may impact you as a homeowner.
For instance, if the HOA is under litigation, it is essential to understand the reasons and potential repercussions. If the building is still under construction, you need to know the expected completion date and how it might affect your property enjoyment. Moreover, you must be prepared to put in extra effort to secure financing.
Pro Tip: For example, in South Florida most recent or new construction condo buildings will have 558 litigation in place against the developer for alleged construction defects. This is fairly common, and since there’s really only upside if they win or settle, this type of litigation shouldn’t be viewed with such a negative light (aside from the running cost of legal fees until the matter is settled).
The Significance of Non-Warrantable Condos and Warrant of Habitability
It’s important to note that non-warrantable condos don’t have anything to do with a warrant of habitability, which typically refers to local housing department certifications that a home is safe to inhabit. Arguably, a warrant of habitability is much more important to secure as without one, your local housing agency may say it’s illegal for anyone to inhabit the property until the unsafe conditions are remedied.
Another thing to remember about non-warrantable condos is because they are not guaranteed by the GSEs, banks may have to hold the loans on their balance sheet, which consumes more capital and thus makes it relatively more expensive of an asset to own. In contrast, conforming mortgages that are guaranteed by the GSEs are easy to package and resell to third party investors via structures such as mortgage backed securities.
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The Bottom Line on Non-Warrantable Condos
Non-warrantable condos, despite not meeting the requirements of the GSEs, are not inherently flawed or defective. There could be a legitimate reason why the condo is non-warrantable, and the property is otherwise perfectly fine. However, before purchasing a non-warrantable condo, it is crucial to understand the reasoning behind its status and be prepared to take a few extra steps to secure financing.
The Role of Government-Sponsored Enterprises in the Housing Market
Government-Sponsored Enterprises (GSEs) such as Fannie Mae and Freddie Mac play a crucial role in the U.S. housing market. They provide liquidity, stability, and affordability to the mortgage market by buying mortgages from lenders, packaging them into mortgage-backed securities, and selling them to investors. This process allows lenders to remove the risk of default from their books and free up capital to make more loans.
However, to protect investors from undue risk, GSEs have stringent standards for the loans they purchase. These standards apply to the borrower’s creditworthiness, the property’s value, and in the case of condos, the financial and operational health of the condominium project. When a condo does not meet these standards, it is classified as non-warrantable, and the loan for its purchase is not eligible for sale to the GSEs.
Financing Options for Non-Warrantable Condos
While securing financing for a non-warrantable condo can be challenging, several options are available to prospective buyers. These include:
Local and Regional Banks
Small local and regional banks often retain their mortgages rather than selling them on the secondary market. As a result, they may be more flexible in their lending standards and willing to finance non-warrantable condos. These banks are more likely to consider the borrower’s entire financial picture and the specifics of the condo project rather than strictly adhering to GSE guidelines.
Credit Unions
Credit unions, like local banks, often keep their loans in-house. Because they are member-owned and not driven by profit, they can sometimes offer more favorable terms and be more flexible with their lending criteria. If you’re a member of a credit union, it may be worth exploring this option.
Portfolio Lenders
Portfolio lenders are financial institutions that keep the loans they originate in their own investment portfolios instead of selling them on the secondary market. Because they don’t need to adhere to GSE guidelines, they can offer loans for non-warrantable condos. However, the interest rates and down payment requirements may be higher than for warrantable condos.
Non-Qualified Mortgages
Non-qualified mortgages (non-QM) are loans that do not meet the standards set by the Consumer Financial Protection Bureau for a Qualified Mortgage. These loans are offered by some lenders to borrowers with unique circumstances, such as self-employed individuals or those seeking financing for non-warrantable condos. Non-QM loans often have higher interest rates and require larger down payments.
Pro Tip: Non-Qualifying Mortgages (Non-QM) are loans that don’t meet the stringent guidelines set by standard mortgage loan programs, making them a viable option for those with unique financial or job situations. These loans can be beneficial for self-employed individuals, high net worth individuals, investors with multiple rental units, those with recent bad credit, foreign nationals, and those seeking an interest-only payment loan option. However, they often require higher down payments and come with higher interest rates and costs. It’s important to remember that non-QM loans are not like subprime loans from the last housing crisis; lenders must make a good-faith effort to verify that you can repay the loan. However, non-QM lenders can create their own guidelines to prove you can afford the monthly mortgage payments.
The Risks and Benefits of Investing in Non-Warrantable Condos
Investing in non-warrantable condos comes with its unique set of risks and benefits.
Risks
The primary risk is the difficulty in securing financing. As discussed, most traditional lenders do not finance non-warrantable condos, and the ones that do often require larger down payments and charge higher interest rates.
Another risk is the potential for lower resale value. Because of the financing challenges, non-warrantable condos can be harder to sell, and sellers may need to accept lower prices.
Finally, the issues that make a condo non-warrantable, such as pending litigation or a high percentage of non-owner-occupied units, could lead to problems down the road. For example, if many units are rented out, the quality of maintenance may decline, affecting the living experience and property values.
Benefits
On the upside, non-warrantable condos can be a good investment opportunity. Because of the financing challenges, these condos often sell for lower prices, potentially providing a higher return on investment if the issues causing the non-warrantable status are resolved.
Additionally, non-warrantable condos can offer the benefits of condo living, such as access to amenities and lower maintenance responsibilities, often at a more affordable price.
The Bottom Line on Non-Warrantable Condos
Non-warrantable condos, despite not meeting the requirements of the GSEs, are not inherently flawed or defective. There could be a legitimate reason why the condo is non-warrantable, and the property is otherwise perfectly fine. However, before purchasing a non-warrantable condo, it is crucial to understand the reasoning behind its status and be prepared to take a few extra steps to secure financing.
Disclosure: Commissions are not set by law or any Realtor® association or MLS and are fully negotiable. No representation, guarantee or warranty of any kind is made regarding the completeness or accuracy of information provided. Square footage numbers are only estimates and should be independently verified. No legal, tax, financial or accounting advice provided.
