CONDO QUESTIONNAIRE: What You Don't Know CAN Hurt You - Part III

by Joe Savage, Real Estate Broker
This is the final installment of the three-part series about the Condo Questionnaire required by lenders who are considering making a loan for the purchase of a condominium unit, which loan would later be sold to Fannie Mae or Freddie Mac, Government Subsidized Entities (GSE) the secondary markets. This month, we cover items in the questionnaire which deal with the condominium’s risk.


There are items in the questionnaire which deal with Home Owner Association (HOA) risks, and how it manages them. The most common forms of risk management are insurance: property, liability, and fidelity. The GSE wants to be sure that the HOA is carrying enough insurance that it won’t suffer damages which could in turn adversely affect its loan collateral…the unit. The GSE require that the insurance “bundle” purchased by an HOA includes coverage for damages to the physical property (Property & Casualty,) damages from a liability claim from someone suffering an injury or damage on its property (Commercial General Liability,) and damages from theft or crime committed by its officers or employees (fidelity bond.) The GSE has guidelines for what percentage of the value of the property is actually insured, and what the deductible must be. If too little of the value is insured, or there is too high a deductible, that affects the amount of risk the HOA (and, by extension, the GSE) is taking, it will affect underwriting decisions.


The other type of risk the GSE are interested in is litigation risk. That is, there is a very specific question about whether an HOA is “…subject to pending litigation.” It doesn’t matter whether the HOA is the defendant in the litigation, or the plaintiff. Mostly, the GSE are looking for two kinds of litigation: 1)Suit for Damages in which the HOA is the defendant (liability, “slip-and-falls”, wrongful death,) and 2)Suit for (Latent) Construction Defects in which the HOA is the plaintiff (HOA sues builder/developer for construction defects.) In the former, the HOA stands at risk of a hefty judgment which could cause unusually large assessments to be levied against its homeowners, and could cause “run-off” of homeowners unable or unwilling to pay. In the latter, there is an implication inherent in the suit that the structure is simply not sound, and may require high expenses to set it right…especially if the builder were to go bankrupt and be unable to pay a judgment for the HOA. Litigation is very complex, however, and most underwriters are not attorneys, so this is a questionnaire item that can derail a loan in a blink. Unless an underwriter can fully understand and be willing and able to defend his/her decision to approve the loan in the face of pending litigation…well, as I said last month, “…it’s easy to say ‘no.’” …and if a buyer can’t get a loan because of unacceptable risk--pending litigation or inadequate insurance--then prices invariably gravitate to “cash purchase” levels, and that can put a serious crimp in property appreciation.


In summary, we are currently experiencing all-time lows in mortgage interest rates; but, we are also experiencing all-time highs in lender risk-aversion…a “tight credit market.” This results in many people wanting to borrow (to buy or refinance) but with few lenders willing to loan except in the most safe circumstances. In order for prices to appreciate in any particular condo complex in such an environment, loans must be available for purchases of its units. Thus, its HOA must be vigilant and proactive in managing the perception by lenders of the complex’s “warrantability”…the likelihood that the lender will be able to sell such loans to the secondary market.