Condominiums, also known as condos, are the perfect home for many people. Some home shoppers choose condos because the prices are often less than single-family homes. Buying a condo can help homebuyers get into their first home, where they can build some equity and eventually sell it and move into a bigger place if that's the goal. Because the prices are often lower for condos, so are the down payments to get into one.
Since condos are individual units in a community-owned building, lenders look at them differently from single-family homes. This doesn't mean they look at condos unfavorably, just that there are different criteria they must follow when lending to condo buyers.
What Makes Condos Different?
In a condo building, owners have full control over the interior of their homes. But the common areas, such as yards, halls, pools, meeting spaces, and other areas, are jointly owned and managed by the condo association.
When lenders decide whether to issue a loan for a condo, their underwriting process takes into account the financial health and stability of the condo project as a whole. That means they look at how many people live in the entire building and what kind of shape the building is in. They also take a good look at the financial health of the condo association, including how many owners are late in their association payments and for how long.
Taking these aspects into consideration, not every condo will qualify for a home loan.
Since condos are just one part of a group of homes, lenders see them as riskier than single-family homes.
Types of Condo Loans
The way you plan on using your condo can affect what kind of loan you'll get. Whether your condo will be your main home, second home, or a property you will rent out will decide how much money you need to put down. Second homes and investment property will require higher down payments, perhaps 10%, 20%, or even more of the purchase price.
Once you've found the type of home loan you need, there are a few kinds of loans to help you with your purchase:
- Federal Housing Authority (FHA) loan
- Veterans Administration (VA) loan
- U.S. Department of Agriculture (USDA) loan
- Conventional loan
FHA Rules for a Condo Loan
Many first-time homebuyers want to use FHA loans because they offer down payments as low as 3.5%. The credit rules for FHA loans are often less stringent as well. On the flip side, FHA rules for condos are stricter than for a single-family home.
Here are a few of the rules for an FHA condo loan:
- FHA-approved condo list: The condo to be listed on the FHA-approved condominium list. If the condo is not on the list, the borrower will need to seek a conventional loan.
- Single-unit approval: In some cases, the FHA will approve certain home loans even if the complex as a whole is not approved. This is only the case if no more than two units in a complex of less than 10 are FHA-insured, and no more than 10% are FHA-insured in complexes of more than 10 units.
- Principal residence: The condo must be your main home. It can't be a second home or vacation home.
- Percentage of FHA loans: At least 80% of all FHA loans in the complex must be owner-occupied. If too many FHA-insured units are turned into rentals, FHA will not approve the loan.
- Percentage of owner-occupied units: A minimum of 50% of the units in the complex must be occupied by the owner.
- Concentration of FHA insurance: No more than 50% of the units in a complex may be FHA-insured.
- Commercial space: No more than 35% of the building or complex can be non-residential space.
- Construction completion: The project must be completed for at least a year, with no additions or phases pending.
Be aware that not only do the rules for a condo loan vary between FHA loans and conventional loans, but each lender's investor may have their own set of rules called overlays. Also, just because FHA says you can get a condo loan does not mean the lender you have chosen will agree to fund such a loan. Take care to vet your lender before moving forward with the loan process.
General Condo Loan Rules
If you can't get an FHA loan for your condo, you can still apply for a conventional loan. Whether you obtain an FHA or a conventional loan, some condo loan rules are the same.
- HOA delinquencies: In complexes where values have fallen across the board, dues often have not been paid for those in short sale status or those which are bank-owned. Percentage minimums apply. Most of the time, at least 85% of homeowner association dues must be up to date.
- Pending legislation: Lenders don't want to see pending legislation in a condo complex. This is because lawsuits can be costly and take a lot of time to resolve.
- Restrictive covenants: A restrictive covenant is a set of rules that outline what actions the real estate buyer must take or abstain from. Many banks will only lend money if the purchase is transferred "in fee simple," which means without restrictions or claims against the property.
- Insurance: The complex must maintain correct insurance such as hazard, liability, and flood insurance if needed.
On top of needing a stable income and decent credit for yourself as a borrower, your chosen condo project must be in good financial health as well.
- Home loan lenders look at the overall financial health of a condo association.
- Your down payment depends on whether you'll live in the condo full time or rent it.
- FHA loans are only given to people who will be living in their condo units.
- A building with too many rental units is likely to be turned down for a home loan.
- Lenders are cautious because condo common areas such as the roof, hallway, and essential systems are owned by a group of people, and any of these people could default.