Our Sovereign Lending Group loan officers are often asked, “Why are mortgage rates higher for condominiums?” As with so many other things in life, whether it be insurance, or penny stocks, or pork bellies, the basic answer is “risk.” But let’s dive in a little further as it is important to understand the underlying issues.
Condos are generally more affordable than single family homes, and a good place for first time home buyers to look. But lenders like Sovereign Lending Group, servicers, and investors are very cognizant of risk. Risk is measured by late payment, defaults, foreclosure rates, the possibility of natural disaster, or home values dropping. Each of these factors, as well as a borrower’s credit score, loan to value (i.e., how much down payment), and occupancy of the property have measurable differences in risk, and therefore impact the pricing to compensate for the risk.
Typically, the least risky type of property is a detached single-family residence (SFR). But significantly riskier, per historical payment data, are condominium units. Condominium owners are in a close business relationship with every other unit owner in the complex and home owners’ association (HOA). The health of the HOA directly impacts the value of your unit.
Neighbors, individually and collectively, make up the board of an HOA, and they pay, or don’t pay, dues to the HOA based on capital improvements, maintenance, and repairs. All of these factors impact the financial health of HOAs, and therefore the value, or ability to sell, units in the complex.
If an HOA starts to have poor fiscal management, has increase in owners who are late, or do not pay, their monthly dues, has not properly maintained the property resulting in leaky roofs, broken sidewalks, or other hazards, the result will be, not only higher dues for owners to cover the shortfalls, but likely being taken off lists of approved condos for lenders. This will result in fewer available loans, therefore fewer qualified buyers, which will result in lower values.
Also, having a potentially negative impact on values will be the occupancy of the units in the complex. One potential risk for lenders is that a large percentage of condos are converted to rental properties. Many Sovereign clients over the years purchased a condo for their first home, then when they are able, purchase a new single-family residence and retain their condo unit as a rental.
Because of this property ownership trend, there is a two-fold risk for lenders with mortgages in a condo complex. First, is the direct risk of their prior owner-occupied loan now being a loan on an investment property. Investment properties are a big risk to lenders are if borrowers are having financial challenges, they are much more likely to let a rental property go to foreclosure than their primary residence.
Second, many condo complexes can see the number of rental units increase over the years, in some instances seeing more than half of the residents being residents. Having fewer owner occupants in a complex tends to see a decline in care for the common grounds and units. Absentee owners are less likely to pay close attention to HOA governance and finances. This can lead to a decline in values.
The vast majority of condo complexes are well run, fiscally responsible and ideal properties for buyers, particularly first-time buyers. But investors often err on the conservative side of things, and therefore the price differential remains between single family homes and condominiums.