Why Financing a Condo is Different From Financing a House

Are you ready to take the next step towards owning your own condo by seeking out a mortgage? Before you get into the nitty gritty of financing options, it’s important to know that securing a mortgage for a condo isn't quite the same as obtaining a mortgage for a single-family home.

Condominiums make up more than 40% of all first-time home purchases, and their popularity makes a lot of sense. Condos are typically located in convenient and desirable urban locations, often at a lower price than a stand alone single-family home, and they often come with onsite amenities such as gyms, pools, or even spas. There’s also the valuable benefit of having the physical management of the property handled by a homeowner’s association (HOA) in exchange for a monthly fee. For many home buyers — especially first-time ones — a condo is the perfect fit.

Whether you’ve already picked out the condo of your dreams or you’re just starting the search, you should understand the key differences between financing a condo and financing a house so you can go into the process informed and ready.

Condo Mortgage Rules Changed After the Housing Crash

The reason the underwriting process — the process of analyzing your risk to determine whether to approve your loan — differs between condo purchases and house purchases stems primarily from the aftermath of the housing crash.

During the housing crash and economic crisis of the late 2000s, there was a very high rate of condo mortgage defaults. This led to the adoption of tighter FHA loan restrictions by mortgage lenders. Enormous losses occurred during the crash, many of which were caused directly by defaults on condo loans, which made lenders somewhat nervous about handing out condo loans in the future. Many mortgage lenders today consider condominium purchases a special risk when compared to house purchases.

Therefore, lenders that offer loans for condo purchases now operate under tighter restrictions for interest rates, and this is something borrowers should be aware of going into the process.

FHA Loans

The popularity of Federal Housing Administration (FHA) loans is due to their low loan-to-value ratio (LTV), requiring as little as 3.5% of the total purchase price for a down payment.

To balance this benefit, FHA loans come with stricter requirements than conventional mortgage loans — such as tighter loan restrictions, tighter credit requirements, and greater limitations on what can be purchased. This ensures that the bank can resell the property in the event of a default. Additionally, FHA condo loans tend to come at a higher interest rate than those for single-family homes.

In the case of a single-family house, the home is appraised and if there is a clean title, it is sold to you. With the purchase of a condo, however, the lender will include additional considerations in its determination of whether to extend a loan, including:

• The reserves and arrearages of the HOA
• The foreclosure status of other units in the building
• The HOA Covenants, Conditions, and Restrictions (CC&Rs)
• Amount of space used for non-residential purposes (must be less than 25%)
• Number of renters vs. homeowners occupying the building (must be at least 50%)
• Comparable sales in the area and in the building
• Number of units in the complex that have association dues more than 30 days late (must be 20% or less)
• Number of existing FHA loans in the complex (must be 30% or less)
• Number of owner-occupied FHA loans vs. rented (must be at least 80%)
• All construction on the unit has been completed for at least 1 year
• Any pending legislation against the HOA
• Complex must be sufficiently covered with hazard, liability, and flood insurance
• Restrictions on the number of units that can be owned by a single investor, depending on the size of the complex
• No foreseeable special assessments on the horizon

These restrictions mean that plenty of condos on the market can’t be purchased with an FHA loan. But that doesn’t mean you are out of luck if you have your heart set on one of these properties.

Conventional Loans

Why not simply purchase a condo with a conventional loan rather than slog through the hefty requirements of an FHA loan? Depending on your finances, this may be an option.

Conventional mortgages are less restrictive than FHA loans because of their specific underwriting requirements — such as an LTV ratio that generally requires the borrower to put down at least 20% of the purchase price.

The advantage of putting 20% down initially is that it allows the homebuyer to avoid paying Private Mortgage Insurance (PMI). FHA loans, on the other hand, require PMI regardless of the size or percentage of your down payment. The disadvantage, naturally, is that 20% is a much heftier down payment than what is required of you for an FHA loan.

Non-Warrantable Complexes

Some complexes may not be approved for FHA or Federal National Mortgage Association (Fannie Mae) loans. These are considered “non-warrantable,” and can make it a bit more challenging to find a loan — as lenders view these housing projects as higher risk investments.

Common examples of non-warrantable properties include house boats, motor homes, or timeshares. If you’re purchasing a condo in a non-warrantable complex, your options include cash payment or securing a local bank loan. Keep in mind, local bank loans often require down payments of up to 50% of the purchase price, and may have much higher interest rates than FHA or conventional loans.

Tighter Loan Requirements Don’t Stop Buyers From Going For Condos

The housing crisis of the late 2000s has widened the gap between single-family home purchase and condo purchase requirements, but that hasn’t made condos any less popular with home buyers — even luxury units.

Offering affordability, convenient onsite amenities, prime locations, and lower maintenance requirements, condos remain one of the most desirable options for homeownership. Although FHA loans have tightened stipulations required for financing a condominium, the restrictions often benefit buyers as much as lenders by ensuring a condo is an equitable purchase, and that the value of the unit is likely to grow over time. This factor itself is a compelling reason to weather the underwriting process necessitated by an FHA condo purchase.

The process of obtaining a condo mortgage may sound a little more messy, but once it goes through, your monthly loan repayments are virtually the same as having a mortgage on a house. A condo purchase is a great way to begin the chapter of homeownership for many new homeowners looking to establish their equity, and can afford borrowers an easier homeownership experience.