The Financial Risks of Buying a Non-Warrantable Condo
Before paying a higher rate and larger down payment, consider these hurdles and potential red flags.
With apartment and condominium community development more common in major metro areas, it makes sense for many homebuyers – especially first-timers – to purchase a condo rather than jump into the overcrowded single-family homebuying pool.
But before you put in an offer on a condo in a building that's still under development, be aware of the financing obstacles you can run into: namely the non-warrantable condo.
A condominium is deemed non-warrantable when it does not meet criteria by Fannie Mae and Freddie Mac to allow for mortgage financing. Beyond the homebuyer’s qualifications for financing the purchase, both entities place additional expectations on the condo community.
Because Fannie Mae and Freddie Mac purchase conventional mortgages on the secondary market, if the condo doesn’t meet its criteria, neither will purchase the loan. Major lenders, which sell loans in large numbers, won't issue a condo mortgage that can't be sold along with other mortgages that have been issued.
Both entities have a long list of requirements for purchasing condo mortgages. To be warrantable, a condo community must meet the following qualifications, among others:
- Construction must be complete.
- More than half of the units must be owner-occupied.
- No individual or company can own more than 10 percent of the condo units in the community; this includes the developer.
- The homeowners association must be under control of the residents, as opposed to the developer.
- More than 75 percent of the residents must be current with the HOA fees.
- The HOA cannot be named in any current lawsuits.
- If the community is not exclusively for residential use, commercial space must be 25 percent or less of the total building square footage.
“When you look to buy a condominium versus single-family home, of course you want to get the best price you possibly can for you and your family, but it’s equally important to know upfront whether ... the project meets the standard of the lender you intend to work with,” says Steven Grossman, a partner at NJ Lenders, a mortgage banking firm that finances condo mortgages and other loans in New York and New Jersey.
It’s still possible to purchase a condo with financing if it turns out to be non-warrantable, but you must consider some additional risks and costs. Be prepared for all possibilities from the beginning of the purchase process. Here are four factors to carefully weigh if you’re looking to purchase a non-warrantable condo.
Last-minute information. To determine if a condo is warrantable, lenders send a questionnaire to the condo HOA to get answers about other units, any current litigation and more. But one of the most frustrating issues with a non-warrantable condo is that you may learn that a conventional loan won't work mere days before the scheduled closing date.
“The issue is usually that the lender doesn’t order the condo questionnaire until the appraisal is done,” says Adam Lesner, a licensed mortgage loan officer in Farmington Hills, Michigan.
To avoid losing out on your condo purchase or pushing back your closing date, inquire about a loan officer’s experience with condo deals before you even begin the application process.
Major lenders won’t budge. If you initially intended to go through a major lender such as Wells Fargo, JPMorgan Chase or Quicken Loans, a non-warrantable condo likely isn’t an option.
“If you’re working with one of the mega-sized lenders, they’re probably not going to do it because bigger lenders right now are only doing A-paper, clean, easy deals,” Lesner says. “The mid- to small-size lenders are going to be the ones who have some exceptions processes in place, or alternative investors who will buy that mortgage.”
Major lenders issue so many loans on a regular basis that they don't have the ability to take on a mortgage that they can't sell on the secondary market with the others. A smaller bank or credit union may be able to consider a loan on a case-by-case basis, as it doesn't sell mortgages on the secondary market at the same volume.
The type of mortgage typically available to a non-warrantable condo is a portfolio loan, which is not repackaged and sold on the secondary market, but kept by the initial lender as part of its investment portfolio.
Less desirable rates. By pursuing nonconventional lending, you’re also moving away from the same low rates available with a conventional loan. If the lender is going to take a bigger chance on you and your condo, he or she will need to see your serious investment in the condo.
“Usually the pricing [for the loan] is not as competitive as what you would find in your agency marketplace,” says Michael Baralt, branch manager and loan officer for McCaughan Home Lending, a division of Hamilton Group Funding Inc. in the Tampa Bay area in Florida.
You’ll usually be expected to provide a larger down payment – as much as 30 percent – and it's likely the interest rate will be higher than a conventional loan on a warrantable condo.
Another alternative is to request a limited review by Freddie Mac, which removes some of the necessary criteria to consider the community warrantable. However, this requires you to put at least 10 percent of the purchase price into a down payment or more, depending on where you live, and the home has to be your primary residence, among other necessary criteria.
Concerning condo community conditions. The biggest concern you should have about a non-warrantable condo is if it’s a good investment for your money. Fannie Mae and Freddie Mac require a lot of qualifications to consider a condo warrantable – and some of those red flags should make you reconsider your purchase.
Grossman says an active lawsuit with an uncertain amount of money the community may have to pay is a huge concern, especially if it’s beyond the condo association's reserves, since community homeowners will have to make up the cost.
Baralt also notes every condo community should have adequate and up-to-date insurance, which often isn’t the case. A condo association's insurance may cover liabilities, legal fees for non-money damage lawsuits, structural damage and employee dishonesty.
“[A non-warrantable condo lender is] still trying to make sure the condominium project is stable and has adequate insurance coverage, which is a big deal,” Baralt says.
If any details of the condo community’s qualifications set off an alarm, reconsider your purchase before taking on a higher interest rate or larger down payment.