This designation is important to anyone who is interested in buying, selling, or refinancing a condo. In short, almost half of the people out there should pay notice. If a condo project is determined to be non-warrantable, it could lead to difficulties in obtaining financing.
Let me first tackle where the term non-warrantable comes from. When a lender sells a loan to institutions such as Fannie Mae and Freddie Mac, they have to place certain warranties on the product they are selling. You could also call them guaranties or certifications. The lender certifies all sorts of things contained in the loan file being sold. They have to guaranty or certify that they obtained a credit report in the manner required by Fannie and Freddie. They have the certify that they have included in the loan file all required income and asset documents required to sell a loan to Fannie and Freddie, and that the income and assets they state on the final application is accurate. They have to certify that the appraisal was ordered in accordance with the rules, and that the appraiser meets the minimum licensing requirements. They also have to guaranty that the collateral – the subject property, is in good condition and marketable.
The lender also has to certify in the case of a condominium project, that the project meets the standards set forth by Fannie and Freddie. When the lender reviews a condo project and finds that it meets those requirements, the lender warrants that they reviewed project and certify that the project meets the requirements.
As with any type of warranty, if something goes wrong with the product, the seller is responsible to the buyer if something happens. In the world of mortgages, if the buyer, Fannie or Freddie, finds that the seller sold them something that didn’t meet what the promised, the seller is obligated to return the money given to them for the loan. We call this a buy-back. Buy-backs are the death to mortgage lenders. The whole mortgage lending system is designed for lenders to lend money to consumers, then sell the loan to an entity like Fannie or Freddie, get their money back, and lend it out again. If the lender has to buy back the loan, it reduces their ability to lend. Get enough buy-backs on your books and you will soon be out of business.
So what makes a condo project non-warrantable? There are lots of reasons. Fannie and Freddie devote huge chapters in their guidelines that look at every aspect of a condo project. The guidelines cover owner-occupancy, litigation, financial health of the Homeowners Association, and a huge one here in Hawaii – does the project allow for short-term vacation rentals.
If the project fails on even one of those areas, the project is classified as being non-warrantable, and ineligible for sale to them. If a lender inadvertently funds a loan in one of these projects expecting to get their money back, they may end up getting stuck holding it, or selling it for a discount to those entities that buy distressed loans.
Does that mean there is no financing for non-warrantable condos? No! Many banks offer what is called a Portfolio Loan. Portfolio loans are loans that the lender funds from their depository assets, and then keeps the loan in their portfolio. The loan is not sold off to Fannie or Freddie. In these cases, only the criteria set by the lender is used.
If there is financing available, what’s the big deal? Portfolio loans generally have higher interest rates than those offered through Fannie and Freddie. But more important, most portfolio loans required higher down payments. Usually, portfolio loans require a minimum of 20% down. In the case of buying a condo that will be a vacation rental, the buyer will need to put 25% to 30% down.
My word of advice this week is to know the collateral (property) you are buying, selling, or trying to refinance. If you think about it logically, if you are asking for someone to lend you money and you are pledging an asset, you should know all you can about that asset before asking someone to lending you money. If you ever watch the show Pawn Stars, you will notice a central theme: If you know everything about that item, you will probably get a higher price. If the item’s true authenticity can’t be certified, the item’s value is significantly diminished. If you translate that to mortgage financing, the more you know about the property, the less likely you are to be surprised about the financing options available to you. And if you think that has nothing to do with value, it does. If you own something no one can finance, you aren’t going to get a premium price for it.