FHA HUD Loan Underwriting Requirements 2017-02-04T18:30:16+00:00

CONDO ALERT –  Yes, condos have looked attractive to many borrowers of lately because they are dropping in price in several areas by more than a few dollars. But so many people are asking why Condos are more difficult to purchase now than ever before. And so many are complaining that lenders are being more difficult when purchasing condos. The main reason?  Many condo associations are under water when it comes to the monthly dues that they collect. So for condominium associations in Washington State having a reserve study is a state requirement and now a FHA/HUD requirement for any association that has units for sale.

FHA rules have been readjusted, with new regulations (starting November 2016) that relax some of the requirements that had been established previously. The Department of Housing and Urban Development’s (HUD) Mortgagee Letter 2016-15 will allow lenders greater flexibility when reviewing condominium documents. HUD will now allow the ratio of owner occupied units to drop to as low as 35% as long as the reserve contributions increase to 20% of their total budget.  The “10% of budget to Reserves” rule still applies to associations with an owner occupancy ratio over 50%.

Among the FHA HUD various requirements is the need for a current Reserve Study. Here is what they say:

“Reserve Study – a current reserve study must be performed to assure that adequate funds are available for the funding of capital expenditures and maintenance. A current reserve study must be no more than 12 months old – if recent events or market conditions have affected the finished condition of the property that information must be included. When reviewing the reserve study, consideration must be given to items that have been replaced after the time that the reserve study was completed.”

FHA Mortgagee Letter 2009-46 B
FHA Mortgagee Letter 2009-46 B was issued November 6, 2009, and modified previous Regulation issued only a month earlier.  Most significant of these changes was the deletion of the 60% funded requirement of a reserve study, and the replacing it with a new requirement that at the association’s budget provide at least 10% of the budget for reserves.

Most people in the industry have interpreted this as a complete elimination of the requirement for a condominium association to have a reserve study.  That is simply not true, and a careful reading of the language that remains in FHA Mortgagee Letter 2009-46 B shows that a reserve study is still required.

Shown below are the citations and excerpts from FHA Mortgagee Letter 2009-46 B that mandate the reserve study requirement.  Admittedly, the letter nowhere contains the explicit statement “prepare a reserve study,” which is unfortunate.  However, the meaning of the language excerpted below from the letter cannot be interpreted to mean anything other than “prepare a reserve study.”

The Letter is divided into several sections.

“Project Approval,” item II – Eligible Projects, states “The Condominium Project has been declared and exists in full compliance with applicable State law requirements of the jurisdiction in which the condominium project is located, and with all other applicable laws and regulations.”

What this means is that if state law happens to require a periodic reserve study, then the Condominium Project MUST HAVE A RESERVE STUDY.  Otherwise, it clearly cannot be in compliance with applicable state law.  Some states that have laws requiring reserve studies are; California, Hawaii, Washington, Nevada, Ohio, Delaware, and Florida.  If your condominium project is located in one of these states, you MUST have a reserve study prepared.

“Project Approval,” item V – Project Eligibility Requirements # 11 – Budget Review, states ” . . . This review must determine that the budget is adequate and:

  • Includes allocations/line items to ensure sufficient funds are available to maintain and preserve all amenities and features unique to the condominium project. . . .”

There is NO WAY to make this determination short of preparing a reserve study.  Those who certify condominium projects as being compliant without having a reserve study are taking a large risk.

This same section goes on to state “In cases where the budget documents do not meet these standards, the mortgagee may request a reserve study to assess the financial stability of the project.  The reserve study cannot be more than 12 months old.”

This language clearly assumes the existence of a reserve study, and states that FHA has the right to demand it.

“Loan Approval,” item IV – Certifications, states “If a project has been previously approved, the lender must certify that it has reviewed and verified the condominium project’s continued compliance with the initial approval requirements regarding investor ownership, percentage of owners in arrears for condominium association fees, owner-occupancy rate and FHA loan concentration rate, and the Lender certifies that the condominium project continues to comply with FHA requirements.”

In essence, the Lender is certifying that a reserve study exists, per the above Project Approval requirements.

“Liabilities and Monitoring,” item III – False Certifications, states “Title 18 U.S.C. 1014, provides in part that whoever knowingly and willfully makes or uses a document containing any false, fictitious, or fraudulent statement or entry, in any matter in the jurisdiction of any department or agency of the United States, shall be fined not more than $1,000,000 or imprisoned for not more than 30 years or both. In addition, violation of this or others may result in debarment and civil liability for damages suffered by the Department.”

The potential penalties for failing to provide a reserve study are completely disproportionate to the level of infraction.  However, the cost to comply, by preparing a reserve study, is very small.  No one should knowingly take this risk.

** We recently got a call questioning this figure. Although its nowhere found in writing the 60% reserve requirement was issued by the Santa Ana HUD/FHA office. Since the Santa Ana office serves the Western region, their rule controls all loan guarantees in Washington State.Click edit button to change this text.