FHA Condo Lending in a New Paradigm

FHA rules on lending for condos have been in the news recently. The rules that govern which apartment buildings the agency can offer lending at are blamed for limiting demand in the condo market and even driving down prices.

The FHA’s rules restrict the FHA from lending in complexes where:

  • More than 50% of the units are not owner occupied
  • More than 25% of a complex’s square footage is for commercial use
  • 15% of the units are 30 days late or more on their HOA dues

While the rules are intended to protect the agency from risks, they may not be appropriate for the post-bust real estate environment. Job losses, stagnant incomes, and high unemployment have caused delinquencies on HOA dues to rise, limiting some apartment complexes’ eligibility for FHA financing programs. Limitations on the number of rental occupants has reduced the number of potential buyers for units in non-eligible condominium buildings and some argue that this pattern has hampered the recovery of markets like Phoenix and Miami where investors are buying up units to convert into rentals.

As pictured above, the 90+ day delinquency rate for the United States on FHA-financed mortgages for both single family and condominiums climbed steadily from 2007 to date. However, the delinquency rate on condominiums is well below that of single family (SFR) properties as evidenced by the spread. While the spread between the two rates has eased, it remains significant.

Furthermore, this pattern of a significant spread between the delinquency rates on single family and condominium loans backed by the FHA is evident in Chicago, Denver, Los Angeles, New York, San Francisco and Washington, DC. Miami and Phoenix are the two exceptions where the delinquency rate on condominiums has outpaced that of single family properties. The divergent pattern for Phoenix only developed in early 2011, when the foreclosure rate on single family properties fell, while the delinquency rate on condominiums has continued to rise. This decline in the spread since 2010 might be indicative of the restrictions on lending in local markets for condominiums relative to single family homes.

The homeownership rate peaked at 69% in 2004 and has since retreated to 66%. Expectations are for more foreclosures in 2012 and 2013 which could drive that rate even lower. The dislocation of homeowners, weak economy, and damaged credit histories will raise demand for rental units. As a result, first-time and low income buyers will find it increasingly difficult to begin the homeownership process in areas with high shares of rental units. Given this shift and the relatively low delinquency rate on FHA condominiums, it may be time for the FHA to reevaluate its condo lending rules.

Ken Fears, Director, Regional Economics and Housing Finance

Ken Fears is the Manager of Regional Economics and Housing Finance Policy. He focuses on regional and local market trends found in the Local Market Reports and the Market Watch Reports . He also writes on developments in the mortgage industry and foreclosures.

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  1. The 25% limit on commercial space is the most incomprehensible rule of all. Buildings in urban areas, with street level commercial space, get income from commercial rentals which supports overall building maintenance. This makes the building more financially secure and not less. And, yes, the inability to get FHA financing has a dampening effect on condo values.