The daily bumper to bumper traffic on Mopac is a constant reminder of Austin’s population boom. Once a small hippie haven, Austin is now the 11th largest city in the United States. With that growth comes increased demand for housing and maximization of land space. About ten years ago, we saw a new wave of development take over downtown Austin as builders responded to the housing needs by ripping down the existing buildings and throwing up a smattering of new, swanky condos. Austins condos are filled with a wide variety of people – poolside at any downtown condo, you may see the retired couple who downsized from their more sprawling suburban digs, young single professionals, or families living out the urban dream with their first baby in tow. While condos appeal for myriad reasons, including 24 hour concierge staff, security, amenities, and proximity, there are things you should know before you set out on a quest to buy a condo.
1. Know what you’re buying – is it warrantable?
If you’re like most people, you probably have no idea what this means. We recently had friends who set out to buy a townhouse style condo in a lovely, central neighborhood in Austin. The price seemed reasonable, the property well-maintained, and the condo was walking distance to local eateries and shops. It seemed ideal until the listing agent asked them to submit a pre-approval letter specifically for a non-warrantable condo. Immediately, they called their lender to get information on what exactly this meant. Yes, the lender responded, they were pre-approved, but the condo’s nonwarrantable status would change the terms of financing and they warned, could cause future resale issues.
So what exactly is a non-warrantable condo? A non-warrantable condo means that it does not meet certain FHA guidelines, and therefore, the loan cannot be sold to the government lending institutions more commonly known as Fanny Mae or Freddie Mac. Generally lenders arrange your financing and then bundle and sell of mortgages to another entity so they don’t have to hold the loan on their books. This 2nd tier of lenders require FHA compliance because they are part of Fanny Mae and Freddy Mac. Because non-warrantable condos do not meet FHA guidelines, the related loans cannot be bundled and sold in this fashion, which means they usually end up sitting on the books of the original lender. Because of their higher risk nature, non-warrantable condo loans tend to come with higher financing costs. That is of course avoidable if you are able to pay cash. Many lending institutions will only offer adjustable rate mortgages, or if you’re lucky, fixed rate financing at higher than market rates. Often lenders also require 20% down on the purchase price.
2. What makes it non-warrantable?
There are several reasons that a condo may be considered non-warrantable. Here are some of the most common:
- Renter/Owner Occupant Ratio: Generally, if more than 50% of the units are occupied by renters rather than owners, a condo is deemed non-warrantable. This is considered a riskier investment because as non-invested parties, renters decrease property values. Think about the mentality of renters – it doesn’t matter much to them if they put holes in the walls or stain the carpets, because they don’t own it and can walk away when the lease is up. Renters are not expected to care for the property like an owner would, which makes it less appealing as an investment.
- Reserve Fund: The physical condo building is owned by the Homeowners Association (HOA), which means that each resident owns a piece of all of the property’s common spaces. Generally, all residents are assessed a monthly HOA fee that goes towards paying all of the bills associated with keeping this building up and running: repairs, cleaning services, the concierge wages, pool upkeep, etc. The board meets annually to set a budget that designates the use of these HOA fees. Under FHA guidelines, the HOA budget should flag at least 10% of its budget for a reserve fund. The reserve fund is basically an emergency fund set aside for major repairs on the building. For example, if the roof needs replacing, there should theoretically be enough money in the reserve fund to cover this expense. If the reserve fund is insufficient or nonexistent, residents are levied a special assessment to cover the cost. This could potentially cause a big cash flow issue for some residents if they get levied additional expenses they were not expecting.
- Insufficient Insurance: Since the building is owned by the HOA, the owners’ individual insurance policies cover the contents of their unit, similar to a renter’s policy. The building itself should have separate insurance that is sufficient to cover major damage – i.e. the roof getting blown off or some other big event.
These are just a few of the reasons a condo can be considered non-warrantable. If there is a specific condo project you are interested in, you can check its status here https://entp.hud.gov/idapp/html/condlook.cfm#sthash.4yIx5ywN.dpuf. Make sure to ask the listing agent if the condo is warrantable or not before making an offer! You may even consider asking your lender if they have a warrantable condo checklist for the HOA or management company to fill out.
3. So the condo you are interested is non-warrantable – what’s the big deal?
First of all, can you obtain financing? Most lenders will require at least 20% down, a healthy credit score (think high 600s +) and a maximum debt ratio of less than 40%. Additionally, are you comfortable taking on an adjustable rate mortgage? This means your interest will be fixed for intervals of 3, 5, or 7 years, but are adjusted after the end of the fixed term which can lead to some scary results. Read here if you need convincing http://www.bloomberg.com/bw/stories/2006-09-10/nightmare-mortgages.
Even if you can pay cash or aren’t concerned about the increased costs of financing, consider your future pool of buyers when you go to sell the unit. Many people simply don’t have the cash to put 20% down and wouldn’t want to deal with the hassles of obtaining special financing. This greatly reduces the resell potential. When our friends found out what non-warrantable meant, they walked away from the deal because although they could afford it, they didn’t want to be dealing with the repercussions down the road.
There are over 2,000 condo units currently under construction in Austin with plenty of old inventory for sale as well. If you want to avoid buying a non-warrantable condo, there should be plenty of other options to choose from.