Getting a Mortgage on Coops and Condos in New York City: the Dust is Clearing

The bank rules relating to obtaining financing for a coop and condo apartments have created continued controversy over the last few years as the influence of Fannie Mae on bank lending practices has expanded. Now, practically all the rules that banks are dictating to borrowers are derived from Fannie Mae guidelines, so the differences between the lending policies of various banks are somewhat minimal. In large measure, the dust has settled and the confusion relating to lending policies have become somewhat stable.

Borrowers should now consider the following issues when seeking a loan:

Equity Requirements
Banks require a minimum of 20% down for any loan under $730,000, and 25% for any loan higher than that. In cooperatives, obviously, the boards’ lending requirements will cause the equity investment to be higher.

“Back End” Rules for Housing Cost Coverage and Credit Scores
Historically, banks relied on a ratio of the owner’s monthly cost of ownership to their income to determine if the applicant was qualified. This rule generally provided that if this ratio was 30% or better, the lender would qualify. However, banks quickly realized that this was insufficient. Borrowers with debt from second homes, personal loans, credit cards and credit lines, auto loans and other sources could easily find themselves in difficulty even if the lending ratio on the purchase appeared favorable.
Thus, for a time, there was a dual evaluation — the specific loan for the home purchase, which was called the “front end” ratio, and a second ratio, referred to as the “back end,” had to meet a minimum requirement of 45%.

The front end has now pretty much disappeared and banks are concentrating very diligently on the back end component to insure that all loans are included in the ratio. The banks’ conservative attitude is to ensure that if a person buys a home and has debt they can comfortably afford, their obligations not merely squeak by. In addition, to obtain the best rates offered by the bank, a borrower needs a credit score of 740 or above. If the score is below 720, banks will use “risk based pricing,” which will increase the interest rate on the loan. A borrower with a credit score of 620, which is generally the minimum, should expect to pay 2% more for the loan.

Ownership Concentrations
In the past, banks were indifferent to the affairs of the building in which the borrower was making a purchase. This is no longer the case. Banks have become acutely aware that the financial health of the building is intimately connected to an apartment’s value.

A great concern centers on the heightened level of risk associated with a high concentration of investor ownership. This has been defined as a case where one party owns 10% or more of the building’s apartments. Banks are concerned that the investor with such a large position may exert influence on the building’s affairs, which might diminish the normal investment in building improvements in order for the investor to protect his cash flow position.

Banks are also anxious that if the investor has financial difficulties or defaults, the impact on the financial health of the entire building could be substantial. In addition, if more than one party owns large concentrations, even if the 10% threshold has not been met, the bank will carefully consider this and may deny the loan.

Another bank concern is in new construction and recent building conversions. In these cases, banks are unwilling to lend if the sponsor/developer’s ownership position exceeds 50%, though in some cases this can even be as high as 70%.

The biggest reason for their hesitancy is due to the uncertainty surrounding the ability of the sponsor/developer to sell the remaining apartments. This creates a significant exposure to existing owners if the sponsor fails to be able to meet his financial obligations. There are numerous stories of newly constructed buildings where sponsors left the unit owners high and dry without covering maintenance costs on the remaining unsold apartments or using building funds or resources for completing or renovating his apartments. This can place a significant financial burden on the other unit owners, who have to cover the cost of operations without these essential funds.

10% Capital Improvement Fund Replenishment
Historically, cooperatives and condominiums have accumulated funds in order to maintain the physical condition of the building over time. However, it has often been the case that the amount that has been accumulated has proved insufficient to actually accomplish its intended purpose. Thus, it is common that additional funds must be collected through assessments. These assessments have proven to be of great concern to banks since they are not predictable and they are not considered in evaluating the borrower for a loan unless the assessment has been previously declared. In order to more accurately reflect the true nature of the long term cost of running a property, banks are now requiring that buildings allocate 10% of yearly maintenance collections for the reserve/capital replacement fund.

This new requirement has created a number of significant issues for buildings. Buildings typically have sought to increase the fund by about 3% a year, which somewhat matches the level of yearly depreciation deduction to which the building is entitled to deduct on its tax return. This has generally created a no or a minimal tax condition for cooperative corporations. However, aside from the necessity to dramatically increase the monthly charge by approximately 7% to conform to the new bank rule, the building will also have to raise the monthly charge to pay income tax on its positive income. Thus, 7% must really be 9% to cover the additional tax. While this onerous condition may be avoided in condominiums, it appears that it cannot be in cooperatives.

There are certain steps a building can take in order to alleviate this burden. Banks are accepting professional evaluations of the building’s condition to more accurate portray its obsolescence, and have been willing to adjust the 10% requirement upon a showing that a lesser sum would be adequate to address the building’s needs.

The good side of this new requirement is that buyers will be able to evaluate the ongoing costs of ownership more accurately since there will be a reasonable assurance that the necessary amount to cover operating costs and future improvements are being regularly collected.

Blacklisted Buildings
In addition to the demands of banks to minimize investor ownership concentrations and augment collections for replacement funds, banks are also carefully making a holistic evaluation of every building to ensure that there are no other issues which could impair their collateral position.

It is now common practice for managing agents to fill out building questionnaires as a condition to a prospective buyer getting an apartment loan. If the bank learns that there are adverse conditions they will not only deny the borrower a loan, they may also blacklist the building for anyone else as well. The following have been reasons for a building to be blacklisted:
• Land leases: If the lease term on the building is shorter than the term of the apartment loan, then it is unlikely to be approved.
• Litigation: If a building has onerous litigation it can impair its ability to be financed at the apartment level.
• Unusually high homeowner arrears: Where the amount of maintenance or common charge owed to the building exceeds 10% of the monthly collected rent, the bank will normally refuse to lend on the building.
• Unacceptable Insurance: Banks will only lend where the building maintains adequate insurance to cover the replacement cost of the property and will insist that the insurance provider be at least “A” rated. If applicable, the bank will also require adequate flood insurance and fidelity coverage equal to 25% of total revenue collected by the building. In addition, the building cannot have an insurance deductible greater than $25,000.
• Excess Commercial Use: If a building exceeds 20% by both footage or income from non-homeowner commercial sources, a bank normally will not lend on the property.
• Building Code Violations: Where there are material building code violations, a bank will insist that these be remedied prior to lending on the property.
• Mechanics Liens and Property Encumbrances: Where the building is materially delinquent in addressing vendor obligations resulting in a mechanics lien, if there is a real estate tax delinquency or there are recorded judgments, a bank normally will refuse to lend on the property.

This is only a partial list of items that banks have used as a reason to deny lending on a property. In many instances it is a subjective evaluation that changes regularly. Suffice it say that we have been advised by some banks to advise them about a pending deal prior to the buyer signing contract in order to make sure that the building being considered is on the bank’s “approved” list.

Investor Loans
A bank will not give an investor loan on a cooperative apartment even if no board approval is required and the owner has the right to rent. Investors are still able to obtain financing on condominiums, although the terms have become more conservative. For loans up to approximately $417,000, the investor can obtain 80% financing. The requirement is 35% equity for any financing above this amount.

Banks typically will not permit a second mortgage on the property, so one can’t rely on the seller or private sources to supplement the bank’s loan proceeds. In addition, banks will be anxious to ensure that the rent being collected on the property is more than sufficient to cover the full cost of ownership, including the common charge, real estate taxes and the monthly loan debt payment. If this cannot be done then the investor must contribute a larger level of equity.

Normally, investor loans are issued at an interest rate premium of .05 to 1.5% of the homeowner rate. The difference depends on the nature of the property, the financial strength of the investor and his/her banking relationship.

Heavy Leverage Loans (90% Financing)
There still is a market for borrowers looking to obtain 90% financing on the purchase of condominium apartments. This is available by the borrower obtaining Private Mortgage Insurance. Thus, the borrower actually engages in a dual arrangement of obtaining a loan from the bank and insurance protecting the bank’s position for any amount borrowed above conventional lending limits. The cost of this insurance adds 6 points at the time of closing (5% of the loan representing the first year’s insurance) and approximately 0.5% more on the monthly payment. The borrower must have a strong credit score and be able to adequately cover the loan payment based on back end rules (see above). Qualifying for private mortgage insurance is often more difficult than qualifying for the loan.

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