What your Condo Association Needs to Know About the New Fannie Mae and Freddie Mac Lending Guidelines

What your Condo Association Needs to Know About the New Fannie Mae and Freddie Mac Lending Guidelines

           The Surfside condominium collapse led to significant reform in the condominium lending industry.  In Lender Letter LL-2021-14, Fannie Mae and Freddie Mac implemented temporary lending guidelines in 2021 for condominium purchasers that desired to secure a mortgage as was previously discussed in Prepare your Condo for the new Fannie Mae and Freddie Mac Lending Requirements.  At the request of FHFA, Fannie Mae and Freddie Mac implemented additional condominium lending guidelines on July 5, 2023, in Selling Guide Announcement, SEL-2023-06.  As will be discussed in greater detail below, the major changes to the condo lending guidelines are as follows:

• • Updating the definition of “critical repairs” that makes a condominium project ineligible for lending.
  • Updating the requirements for building inspection reports for condominiums to determine whether the structural and mechanical components of a condominium are in need of critical repairs.
  • Updating the definitions of “litigation” and “pre-litigation” activities that may make a condominium ineligible for lending.
  • Updating the guidance on reserve study requirements for condominium associations.
  • Updating the underwriting requirements related to special assessments imposed by condominium associations.

Community association managers, condominium associations, condominium purchasers and real estate agents, should be aware that mortgage companies may incorporate the new condo lending requirements into the underwriting process immediately, but that lenders must implement the new guidelines no later than September 18, 2023.  Similarly, complying with the below updates is important to keep a condominium project off of the infamous Fannie Mae and Freddie Mac blacklists, which have already identified at least 1400 buildings across the country that are now ineligible for lending.

Critical Repairs

            As indicated in the prior lending guidelines, condominium projects that need critical repairs are deemed to be ineligible for the purposes of lending.  The recent updates to the condominium lending guidelines redefined critical repairs, creating a more stringent standard for building maintenance, which is now defined as follows:

Projects in Need of Critical Repairs Projects in need of critical repairs are those needing repairs or replacements that significantly impact the safety, soundness, structural integrity or habitability of the project’s building(s), or the financial viability or marketability of the project. Critical repairs include conditions such as:

• • material deficiencies, which if left uncorrected, have the potential to result in or contribute to critical element or system failure within one year;
  • any mold, water intrusions or potentially damaging leaks to the project’s building(s);
  • advanced physical deterioration;
  • any project that failed to pass state, county, or other jurisdictional mandatory inspections or certifications specific to structural safety, soundness, and habitability; or
  • any unfunded repairs costing more than $10,000 per unit that should be undertaken within the next 12 months (does not include repairs made by the unit owner or repairs funded through a special assessment).

Examples of some items to consider include, but are not limited to, sea walls, elevators, waterproofing, stairwells, balconies, foundation, electrical systems, parking structures or other load-bearing structures.

If damage or deferred maintenance is isolated to one or a few units and does not affect the overall safety, soundness, structural integrity, or habitability of the project, then these requirements do not apply.

Routine repairs are not considered to be critical and include work that is:

• • preventative in nature or part of normal capital replacements (for example, focused on keeping the project fully functioning and serviceable); and
  • accomplished within the project’s normal operating budget or through special assessments that are within guidelines.

A project with an evacuation order due to an unsafe condition, either for a partial or total evacuation of the project’s building(s), is ineligible until the unsafe condition has been remediated and the building(s) is deemed safe for occupancy.

Inspection Reports

            The new condo lending guidelines imposed more stringent requirements related to inspection reports, which are now described as follows:

If a structural and/or mechanical inspection was completed within 3 years of the lender’s project review date, the lender must obtain and review the inspection report. The report cannot indicate that any critical repairs are needed, no evacuation orders are in effect, and no regulatory actions are required. If the inspection report indicates there are unaddressed critical repairs, the project is ineligible until the required repairs have been completed and documented accordingly. The lender must review an engineer’s report or substantially similar document to determine if the repairs completed have resolved the safety, soundness, structural integrity, or habitability concerns of the project.

            Accordingly, if a condominium association has an inspection report indicating that a critical repair is needed or building code violations exist, it will need an engineering report, or report to demonstrate that the building is safe, and the condominium is eligible for lending.

Litigation or Pre-Litigation Activity

            Under the prior lending guidelines, certain types of litigation made a condominium project ineligible for lending.  The new lending guidelines also indicate that certain types of pre-litigation activities, such as mediation, may make a condominium ineligible for lending.  Specifically, the new guidelines state as follows:

Projects in which the HOA or co-op corporation is named as a party to pending litigation, or for which the project sponsor or developer is named as a party to pending litigation that relates to the safety, structural soundness, habitability, or functional use of the project are ineligible for sale to Fannie Mae.

If a lender discovers that a project is engaging in pre-litigation activities (such as, but not limited to, arbitration or mediation) that are reasonably expected to proceed to formal litigation; the lender must apply Fannie Mae’s litigation policies. Whether the legal action is resolved through arbitration, mediation, or it proceeds to litigation, there is risk that the project is exposed to material financial hardship related to the matters addressed in the complaint.

If the lender determines that pending litigation involves minor matters with no impact on the safety, structural soundness, habitability, or functional use of the project, the project is eligible provided the litigation meets one or more of the following:

• • non-monetary litigation including, but not limited to neighbor disputes or rights of quiet enjoyment;
  • litigation for which the insurance carrier has agreed to provide the defense, and the amount is covered by the HOA’s or co-op corporation’s insurance;
  • the HOA or co-op corporation is the plaintiff in the litigation and upon investigation and analysis the lender has reasonably determined the matter is minor and will result in an insignificant impact to the financial stability of the project;
  • the reasonably anticipated or known damages and legal expenses are not expected to exceed 10% of the project’s funded reserves;
  • the HOA or co-op corporation is seeking recovery of funds for issues that have already been remediated, repaired, or replaced and there is no anticipated material adverse impact to the HOA or co-op corporation if funds are not recovered;
  • litigation concerning localized damage to a unit in the project that does not impact the overall safety, structural soundness, habitability, or functional use of the project; or
  • the HOA or co-op corporation is named as the plaintiff in a foreclosure action, or as a plaintiff in an action for past due HOA or co-op assessments.

Litigation that involves personal injury or death does not meet Fannie Mae’s criteria for minor litigation unless:

• • the claim amount is reasonably anticipated or known,
  • the insurance carrier has agreed to provide the defense, and
  • the reasonably anticipated or known damages are covered by the HOA’s or co-op corporation’s insurance.

Construction defect litigation in which the HOA or co-op corporation is the plaintiff are not considered a minor matter unless the HOA or co-op corporation is seeking recovery of funds for issues that have already been remediated, repaired, or replaced. In addition, there is no anticipated material adverse impact to the HOA or co-op if the funds are not recovered.

The lender must obtain documentation to support its analysis that the litigation meets Fannie Mae’s criteria for minor litigation as described above.

Reserve Study Requirements

            The new condo lending guidelines imposed more stringent requirements related to reserve studies, which are now described as follows:

Reserve studies may be used to determine the appropriate level of reserves the HOA must maintain to ensure the project’s long-term success. Reserve studies will also provide useful information regarding the adequacy of the HOA’s current reserve funds and offer recommendations to meet funding goals in the event the HOA has under-reserved for its needs in the past. The lender may review the most current reserve study or a reserve study update provided it has been completed within three years of the date on which the lender approves the project. Reserve studies must be prepared by an independent third party that has specific expertise in completing reserve studies. This expertise may include any of the following: a reserve study professional with reserve study credentials, a construction engineer, a certified public accountant who specializes in reserve studies, or any professional with demonstrated knowledge of and experience in completing reserve studies. While Fannie Mae does not require that a standard format be used for the reserve study, the following items must be addressed: all major components and elements of the project’s common areas for which repair, maintenance, or replacement is expected; the condition and remaining useful life of each major component; an estimate of the cost of repair, replacement, restoration, or maintenance of major components; an estimate of the total annual contributions required to defray costs (minus the existing reserves funded for this purpose), including inflation; an analysis of existing funded reserves; and a suggested reserve funding plan. Note: Individual states may have various statutes concerning the use and content of reserve studies.

Fannie Mae requires that a reserve study used by the lender in its analysis meet or exceed requirements set forth in relevant state statutes.

            In both Michigan and Illinois, there are currently no specific reserve study requirements as to format, so the above guidance should be used when commissioning a reserve study.  As recommended above, it is a good idea to have a reserve study performed and then updated every three years by a qualified professional.

Special Assessments

            The new condo lending guidelines now require lenders to take a closer look at any special assessments imposed by condominium associations, and impose the following requirements:

Special assessments may be current or planned. Lenders must obtain and review the following information for each special assessment to determine if it addresses a critical repair:

• • what is the purpose of the special assessment,
  • when was the special assessment approved and is it planned (approved by the unit owners, but not yet initiated by the board) or already being executed,
  • what was the original amount of the special assessment and the remaining amount to be collected, and
  • when is the expected date the special assessment will be paid in full.

If the special assessment is associated with a critical repair and the issue is not remediated, the project is ineligible.

Accordingly, based on the above requirements, it is important for condominium associations to be as accurate as possible in calculating reserves, and budgeting for annual assessments during the year, as special assessments will receive increased scrutiny by lenders and may make a condominium project ineligible for lending.

Key Takeaways for Condo Associations to comply with the updated 2023 Fannie Mae and Freddie Mac Lending Guidelines

2. Perform Regular Inspections and Maintenance. Condominium associations that perform regular inspections and maintenance are much more likely to remain eligible for financing. Accordingly, condominium associations should consider adopting a regular inspection schedule and ensuring that maintenance is performed in a timely manner.  If an inspection report identifies a problem, a timely plan of action is essential.
3. Maintain Appropriate Records. Every update from Fannie Mae and Freddie Mac seems to require condominium associations to provide more and more information. Condominium associations and property managers should have readily available board meeting minutes, engineering reports, inspection reports, reserve studies, and repair records to respond to lender requests in a timely manner.
4. Have Attorneys Prepare Litigation Status Reports. Fannie Mae and Freddie Mac will now require information related to pre-litigation, as well as litigation activities.  Accordingly, if the condominium association has an attorney involved, it is best that the attorney for the condominium association drafts a status report that accurately describes the litigation.  In cases where insurance defense counsel is representing the condominium association, they may indicate that providing these types of reports is outside the scope of their representation, so general counsel for the condominium association should be contacted.  Inaccurate litigation status reports could lead to a condominium association being deemed ineligible for financing, so it is best that an attorney prepares these reports.
5. Perform Regular Reserve Studies. While most states do not mandate reserve studies, the best practice is for a condominium association to obtain a reserve study and have it updated every 3 years.  Similarly, if a reserve study is not statutorily required, we recommend that a condominium association amend its condominium bylaws to require a reserve study be performed and updated at least every 3 years to ensure that this happens and the reserve study does not become an expense that is cut out of the condominium association’s budget.
6. Stay Away from Special Assessments. Special assessments have the potential to disqualify a condominium until critical repairs are completed.  Accordingly, condominium associations are better off increasing their annual budget to account for all potential maintenance and repairs, than having to impose additional or special assessments as issues arise throughout the year.  Accordingly, condominium associations should not skimp on maintenance and repairs in the annual budget to keep assessments artificially low.

Kevin Hirzel is the Managing Member of Hirzel Law, PLC and concentrates his practice on commercial litigation, community association law, condominium law, Fair Housing Act compliance, homeowners association law and real estate law. Mr. Hirzel is a fellow in the College of Community Association Lawyers, a prestigious designation given to less than 175 attorneys in the country. Mr. Hirzel has been recognized as a Michigan Super Lawyer’s Rising Star in Real Estate Law by Super Lawyers Magazine, a Leading Lawyer in Condominium & HOA law by Leading Lawyers Magazine, and as a Best Lawyer in Real Estate Law by U.S News and World Report’s Best Lawyers Publication. Hirzel Law, PLC represents community associations, condominium associations, cooperatives, and homeowners associations, in Michigan and Illinois. He may be reached at (248) 986-2290 or kevin@hirzellaw.com.