Author: Chris Trusk, Esq.

The FHA and GSEs require certification of several conditions before they will insure or purchase loans secured by a condominium. These requirements touch on the nature and condition of the property, the use of the property, the character and extent of any restrictions on the property, and several aspects of the governing Association.
Although distinctions between Condos or Townhomes are largely semantic, the nature of the property driving those names will affect the requirements imposed by the FHA and applicable GSEs. For instance, different requirements are triggered if the underlying units are attached or detached, if the project is built in separate phases, or if the project uses new construction or a converted, existing structure. These distinctions will determine both requirements for eligibility and the review required for approval. This memo will limit its discussion to condo projects that are either under construction or less than 1 year old with more than 10 attached units located in a single building, to be completed in a single phase. Because this project will be either less than 1 year old or under construction, this memo will also omit litigation and assessment requirements; it should be noted, however, that pending litigation within the project or a threshold of assessments in default may make a project ineligible for FHA or GSE requirements.
Approval
For a mortgage loan secured by a condo unit to be eligible for FHA insurance, it must be approved through one of two avenues: the HUD Review and Approval Process (HRAP), in which review is conducted by FHA staff, and the Direct Endorsement Lender Review and Approval Processing (DELRAP), in which review is conducted by an approved mortgagee. Once approved through either process, the project must be recertified every two years, commencing from their placement on the list of approved projects.
A brief review of HUD-approved projects, available at https://entp.hud.gov/idapp/html/condo1.cfm reveals that of the 233 project submitted for FHA approval, 63 were rejected or withdrawn, and the vast majority of projects were submitted for HRAP review, with only 23 projects submitted using DELRAP review.
New condo projects may be approved for FNMA eligibility using either FNMA’s full review, certified by an approved lender, or the “Project Eligibility Review Service,” conducted by FNMA staff. FHLMC will accept eligible projects already approved by FNMA if the lender certifies that they meet the applicable FHLMC requirements.
Owner Occupancy and Deed or Leasing Restrictions
The use, occupancy, and leasing of the project’s units is a major area of scrutiny for FHA, Fannie Mae, and FHLMC. Each entity provides a maximum percentage of units that may be leased for a project to be eligible.
For new projects and projects under construction to be FHA eligible, the percentage of units that must be owner-occupied depends upon the number of pre-sales: for projects with 30% of units pre-sold, 30% of the units not held by the developer for sale must be owner-occupied, and no more than 30% may be owned by an investor. These percentages change with the percentage of units pre-sold, up to 50%, which requires 50% of the units be owner-occupied, and no more than 50% be investor-owned. Pre-sales must at least provide evidence that the subject units are under contract or closed with the developer’s signed certification.
For a “new project” to be FNMA eligible, at least 50% of the units must be owned or under contract as primary or secondary residences, and no single entity may own more than 10% of the units. For a “new project” to be FHLMC eligible, 70% must be owner-occupied. FHLMC applies the same rules as FNMA with regard to single-entity ownership.
While the FHA and GSEs require certain owner-occupancy levels for eligibility, the FHA and FHLMC each limit restrictions on leasing. FHA cannot insure loans secured by property subject to legal restrictions on conveyance, including leases. However, FHA will permit the following lease restrictions:
• All leases must be in writing and subject to the declaration and by-laws of the project.
• The Association may request and receive a copy of the agreement
• The Association may request the names of all tenants, including the tenant’s family members who will occupy the unit
• The unit owners are prohibited from leasing their units for an initial term of less than 30 days
• The Association may establish a maximum allowable lease term
• The Association may establish a maximum number of rental units within the project (and the number may not exceed the owner-occupancy requirement).
• The Association may not require a that it or its agent approve a prospective tenant, including for creditworthiness
Many affordable housing programs include conveyance restrictions. If the condominium project includes units restricted by such a program, the restrictions will not make the project ineligible if the program is meets certain exceptions contained in 24 C.F.R. 203.41(c) and (d)., or if the project’s recorded declarations contain the housing program’s requirements and define the specific units covered by the program.
Further, FHLMC requires that for new projects, the project documents or state law must require approval by mortgagees representing at least 51% of the unit votes for any amendments to the project documents “of a material adverse nature;” prior versions of this rule listed leasing restrictions as materially adverse.
FHA also will not insure loans secured by property subject to certain deed restrictions. This includes restrictions that would cause a conveyance by the borrower to;
• Be void or voidable by a third party;
• Be the basis of the borrower’s contractual liability;
• Terminate, or subject to termination, the borrower’s interest in the property;
• Be subject to the consent of a third party;
• Be subject to limits on the amount of sales proceeds a borrower can retain;
• Be grounds for accelerating the insured mortgage; or
• Be grounds for increasing the interest rate of the insured mortgage.
Residential Use Requirements
Across FHA, FNMA, and FHLMC requirements, a project is ineligible if more than 25% of the square-footage is used for non-residential purposes, i.e. commercial space. The FHA does allow for a case-by-case exception for certain criteria up to 35%, and any requests for exception greater than 35% are purely at the discretion of the FHA. If a project has been designated “live/work,” meaning that the project is legally sanctioned for non-residential use within the residential condo units, the same 25% non-residential limits will apply, determined by the portion of square footage set aside for residential and non-residential purposes.
Insurance Requirements
For FHA, FNMA, and FHLMC approval, the project must meet the respective insurance requirements for Liability, Fidelity/Crime, Property, and Flood.
FNMA requires that the HOA maintain a master property policy covering the full insurable replacement cost of the project’s improvements, including units, as well as a Residential Condominium Building Association Policy covering all property and individual units. The HOA must also maintain a CGL policy for the entire project, including any areas under HOA supervision, as well as commercial space owned by the HOA, at least covering $1 million for bodily and property loss in single occurrence. The policy must provide at least ten days’ notice to the HOA and each first-mortgage holder before the insurer may cancel or substantially modify it. The HOA must also carry a blanket Fidelity Bondfor anyone handing funds, including management agents, with the same notice requirements.
FHA also requires Property, Liability, Fidelity, and Flood Insurance. FHA requires that Fidelity Bonding be either the state maximum amount or the sum of three months assessments plus reserve funds. FHA also requires that flood insurance cover both the individual unit owners as well as the common areas. The FHA similarly requires that the HOA maintain Property insurance to the full replacement cost of the project, and does not allow unit owners to provide Gap Coverage if the HOA does not provide 100% coverage.
Homeowner’s Association Requirements
In order to be eligible under for FHA insurance, the project’s HOA must meet several requirements. Control of the HOA must pass to the unit owners either 120 days after 75 percent of the units have been sold, three years after completion, or as prescribed under local law. FNMA and FHLMC each require that the developer not retain any ownership interest in any of the facilities after control passes to the HOA. The FHA also requires that any management or employment contract be terminable by the HOA with up to 90 days notice.
Both FHA and the GSEs require review of the project’s budget and financial documents. For projects under construction, FHA requires the current year’s projected budget, and may request bank statements. Completed projects will also require a current balance sheet.
Both FHA and FNMA require that the HOA’s projected budget adequately account for allocations sufficient to maintain and preserve all project amenties, as well as provide replacement reserves for capital expenditures and deferred maintenance equal to at least 10% of the budget. FHA also requires that the budget adequately provide for insurance coverage and deductibles. FNMA allows the following items to be excluded from the capital reserve calculation:
• Income collected for utilities typically paid by individual unit owners;
• Income allocated to reserve accounts; and
• Special assessment income.
FNMA recommends a reserve study to determine the appropriate levels of reserves, and will allow a lender determining the project’s eligibility to use such a study in lieu of calculating the replacement reserve under certain conditions.

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Mortgagee Letter 2015-27, p. 4.
A unit is owned by an investor for the purposes of FHA eligibility if it is not owner-occupied, other than those held by the developer for sale that were not previously rented or occupied.
See Mortgagee Letter 2012-18, § 3.4.
FNMA Single-Family Selling Guide B4-2.2-03
This does not include the Developer’s vacant units. Rented units owned by the Developer are included, even if the tenant has a right to purchase.
Freddie Mac Single-Family Seller/Servicer’s Guide 42.6(c).
24 CFR 203.41(b).
Condominium Project Approval and Processing Guide, §1.8.9.
Freddie Mac Single-Family Seller/Servicer’s Guide 42.6(c), a project in which (i) the project and related facilities owned by any Master Association are not complete or are subject to additional phasing; (ii) fewer than 90% of the total number of units in the project have been conveyed to the unit purchasers other than the developer; or (iii) the developer has not turned over control of the Homeowners Association to the unit owners.
Freddie Mac Single-Family Seller/Servicer’s Guide 42.6(i).
Condominium Project Approval and Processing Guide, §1.8.8.
See Fannie Mae Single-Family Selling Guide § B7-3-01 et seq.
See Fannie Mae Single-Family Selling Guide § B7-4-01
See Fannie Mae Single-Family Selling Guide § B7-4-02
Condominium Project Approval and Processing Guide, §2.1.9
See Condominium Project Approval and Processing Guide, §2.1.6 and See Fannie Mae Single-Family Selling Guide § B4-2.2-02.