Condo and co-op buyers often assume that if they've got money in the bank, a solid credit history, and steady income, they'll have little trouble getting a mortgage. Not so fast: the bank has to sign off on the building just as they would the borrower, and the process is trickier than you'd expect.
Most lenders—especially the big banks—follow guidelines from Fannie Mae that set out whether a building is a safe investment, or "warrantable" in the lingo of the industry. "When your lender tells you that you’re preapproved, they mean you’re preapproved, not that the building is preapproved," explains Rolan Shnayder of H.O.M.E. Mortgage Bankers. "You usually don't find a problem with the building until you’re very close to closing."
While different lenders have different policies, some types of buildings will raise red flags for most of them. Below, some of the most common problems to look out for, and how to get around them:
- Not enough money in the bank. You're not the only one here whose finances are being vetted. If a bank is lending in a building, says Shnayder, they'll want to make sure there's a line item in the building's budget for recurring reserves, i.e. that the building will be able to cover costs if unexpected expenses like a lawsuit or major repairs arise. More specifically, Fannie Mae guidelines dictate that a building should set aside 10 percent of its revenue for reserves. To find this information, your attorney or lender would have to look carefully at the board's budget, though Rochelle Crespi, a mortgage banker with GuardHill Mortgage notes, "Most buildings know this is the standard rule and make sure to meet it. If anyone has gotten a mortgage or re-financed in the building, it will already have come up."
- Legal troubles. If the building is involved in litigation—be it from a resident, an employee, or any other party—about the property's structural integrity, most lenders will refuse to give you a mortgage to buy an apartment there. Fannie Mae guidelines nix anything with lawsuits attached, but as Mortgage Master, Inc. broker Peter Costakos points out (and as many of us know firsthand), people sue buildings for trivial reasons all the time. Often, "lenders are allowed to make judgment calls based on the litigation," Costakos says. In this case, they'll likely need a letter from an attorney involved with the case explaining the situation, at which point, your lender can determine whether the issue is minor or something more serious. This is a relatively rare issue, but, Crespi notes, litigation tends to be more common in co-ops than condos.
- Stores or offices taking up too much space. Fannie Mae's standard rule is that if commercial space, like a Duane Reade or doctor's office, takes up more than 20 percent of the building, mortgages are a no-go, explains Shnayder. If your buyer's broker is at all familiar with the building, they should know right off the bat whether or not this is an issue, says Crespi. "I don't see this problem too often," she adds, "but if you find the right lender, it's possible to get around it."
- Not enough buyers (yet). This one's an issue that tends to crop up if you're buying in new construction—a building needs to have at least 70 percent of its apartments already in contract to be considered "warrantable." But lenders not working with Fannie Mae may be willing to go as low as 50 percent, Crepsi says. However, warns Costakos, if the developer is renting out the rest of its empty units instead of selling them, it will be ineligible for Frannie and Freddie loans, which are based on national standards and risk factors—as opposed to NYC's ever-booming market—and regard rental units as more of a risk. Still, new developments tend to have "preferred lenders"—or one lender that will handle financing for the whole building—lined up to get around this issue. If you're buying in the building, you won't be obligated to opt for this option, but it can be easier than shopping around. (Sometimes, however, the mortgage interest rates are higher.)
- One owner with too much power. Technically, if any one party—be it a sponsor or an individual shareholder—owns more than 10 percent of the building's shares, banks may balk, for fear of putting too much of a property's financial future in a single set of hands. After all, if a shareholder who owns a huge portion of the building goes bankrupt and stops paying maintenance, this will mean rising maintenance costs for the rest of the residents, which can lower property values, meaning your apartment—and the bank's investment—is worth less (it's the same idea behind requiring new construction to have a certain amount of units already sold). Costakos notes that this is far easier to get around in co-op buildings, where one sponsor or investor can often own up to 49 percent of shares, and even rent out those units without causing any problems. Since co-ops are so specific to NYC, banks tend to understand their structure better, as opposed to condos, which adhere to national lending guidelines.
- A landlease. Banks are often hesitant to lend to buyers in landlease buildings, a comparatively rare setup in which the land is owned by a separate investor, rather than the shareholders; the uncertainty that creates (possible rent hikes and lower property values, or the prospect of the owner selling the land) makes banks nervous. However, it's not a surefire dealbreaker, and your potential for a loan depends in large part on the building's lease. "Landlease doesn't exactly mean 'non-warrantable,'" says Shnayder, who notes that if the building's lease is longer than the term of your loan—i.e. your mortgage is for 30 years and the building's current lease lasts for 50—you shouldn't run into any problems. But "if the building's lease comes up during the terms of your mortgage, then the bank doesn't know how to calculate risk," he explains, and isn't likely to want to lend.
While it may seem daunting to get a mortgage in one of these buildings, it can be done. Here are a few strategies to ease the process:
- Find an adaptable lender: Some lenders don't sell their loans to Fannie Mae, and thus don't have to follow the same guidelines. Smaller firms can often find portfolio investors to put together financing for apartments in buildings that might not otherwise be approved. As Shnayder puts it, "When you're lending your own money, you get to make your own rules." Your broker or your attorney are likely your best bets for referrals, says Crespi, and you can specify that you're interested in a non-Fannie Mae lender that works with a larger number of banks (i.e. not just one monolithic lender).
- Get everyone working for you: As soon as you see a building you like, says Warburg Realty broker Jason Haber, you or your real estate broker should get in touch with your mortgage lender to ask if they've lent before in the building, and to research any potential red flags, like current litigation. "Communication is everything, and that means everyone—the board, the buyer's broker, the attorney, and the lender," should all have an ongoing dialogue, Costakos says. Often, your buyer's broker will be aware of a building's problems from the get go, particularly if they've done deals there before or specialize in the neighborhood. Even if the building isn't already on a lender's list of approved properties, says Haber, "it could just be a matter of them submitting updated financials."
- Protect yourself in the contract: Push for a funding contingency in your purchase contract, in addition to a standard mortgage contingency, which will ensure you won't lose your down payment if it's the building—and not you—that fails to win approval.
- Pay a higher rate: Throwing money at the problem may be your best (if imperfect) option, though "a higher rate is not the Band-Aid to a bad situation," Crespi cautions. "I wouldn’t want buyers to think that if you just pay a higher rate, everything wrong with a building gets taken care of." That said, "generally speaking, you can get financing in any building, and it's the rate that's going to be the differentiator," Shnayder says. How this plays out depends heavily on the building, your finances, and the structure of your loan, but for example, Shanyder says, the rate for a standard five-year adjustable rate mortgage is currently around 2.75 percent. Depending on how "non-warrantable" the building is, this percentage could go up anywhere from a half a point to two points in order to get the deal done. But "most buildings out there don’t have problems," says Costakos, and in fact, "the majority of them don’t." So take comfort, but do your research—and have your lender do theirs—before you sit down at the closing table.
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