When shopping for a home, there are differences when buying a condo vs buying a single family home. Unlike single family homes, you don't own the land on which the property's been built when you're buying a condo. At condos, the HOA rules the roost. That means that while you'll own your condo unit, you're sharing space with people, and will be held responsible for meeting certain criteria.
This is because when you buy a condo, you're entered into the HOA as a shareholder. HOAs act as for-profit companies, where the shareholders are the tenants, and reserves (or lack of) directly impact all unit owners.
When Buying a Condo, Rates are Slightly Higher
It's no surprise that many people are buying condos to save money. While luxury condos do exist, for the average person, buying an apartment is cheaper than buying a single family home.
Buyers are often surprised by the fact that condos tend to come with slightly higher mortgage interest rates. This is because condos come with risks that are outside of the borrower's control.
HOAs with Less Than 10% Reserves May Ask for 25% Down
Some of the risk factors that are outside of the borrower's control include:
other borrowers in the condo building defaulting on their loans and maintenance fees
A badly managed HOA budget with low reserves
Repairs the building may have to undergo in the near future
When buying an apartment, the HOA must disclose their budget, as well as what percent of reserves they have. This is very important for buyers to be aware of. HOAs are entities that manage condos as for profit businesses. When you buy a condo, you enter into an agreement with the HOA that you'll follow their rules and guidelines.
But let me ask you this, would you want to own any part of a company that isn't well managed?
Put simply, the answer is no.
You can tell if an HOA badly manages their budget if their reserves are less than 10%. This means that proper planning and spending aren't being implemented. This is a huge risk to the borrower, because Fannie Mae and Freddie Mac will rely on a higher down payment (in this case 25%) in order to secure their investment when they issue you a mortgage.
An HOA's budget reserves are used for large overhaul spending, such as fixing pools, roofs, or other improvements that affect the overall building.
An interesting side note is that some HOAs are certified by Fannie Mae and Freddie Mac. These associations are seen as less risky investments. However, these HOAs still reserve the right to demand a 20% down payment from potential buyers. That's because they are still a corporation, and retain the right to set a certain standard for their shareholders.
Negotiate Price Down if Seller is Behind on HOA Payments
Of course, while the HOA is responsible for building maintenance, tenants are responsible for paying maintenance fees. If for some reason a seller defaults on their mortgage, they still owe the HOA maintenance fees—even when they're no longer owners.
Due to this, many sellers in this situation will ask that the buyer pay their debt as a condition to buying the home, in order to remove the lien off of the property and bring it back into the HOA's good graces.
If you find yourself shopping for a condo and run into a situation like this, there's no reason why you can't buy the apartment. Just know that you have leverage to negotiate down the current price of the apartment. Since you'll be paying the seller's debt to the HOA, there's not much room for them to refuse such a practical request.
You May Need a Piggyback Loan
Because buying a condo is seen as a riskier investment, Fannie Mae and Freddie Mac are only willing to partially invest in your mortgage. If an HOA’s reserves are less than 10%, Fannie Mae and Freddie Mac may require you to get two mortgages—otherwise known as a piggyback loan. Fannie and Freddie will fund up to 75% of the home value on the first mortgage, and you'll be responsible for funding the second mortgage.
I know what you're thinking; how could I fund a mortgage? Remember that 25% down payment requirement I was talking about? Your 25% down payment would be split up into two parts: an upfront down payment and a second mortgage. You could essentially make an upfront down payment of 10% at closing, have Fannie and Freddie fund 75% of your home loan on your first mortgage, and tack on the other 15% of your 25% down payment onto your second mortgage.
Piggyback loans were made to save borrowers money. In fact, because they break up larger loan values into manageable chunks, you get several benefits. Piggyback loans offer no private mortgage insurance and no closing costs on your second mortgage.
If You Shop Smart, You Can Put 3% Down
While buying a condo can be tricky, it can be done easily with the right home buying team. Rate Leaf provides borrowers with the resources to navigate the saturated real estate market.
Although rates offered on condos are normally prime plus (this can mean anywhere from 5% to 6%), how you structure your mortgage can make all the difference. Rate Leaf can qualify buyers for down payments as low as 3%—so long as their financial history makes this possible.
Since the US has reignited housing starts across the nation, waves of hopeful first time homeowners are flooding the market. But many buyers only have the blind trust that they place in their real estate agents to guide them.
My goal is to change that, so that we can make home buying more secure and affordable—for everyone.