By Jeffrey A. Rembaum, Esq. / Published March 2022
Buying a bundle of home loans to later sell on the secondary market can be risky business. A lot can go wrong in the process. For example, the economy could tank, causing massive defaults; or even worse, as occurred recently in the case of Champlain Towers South, the building could collapse—where not only did many residents die, but also insurance proceeds are unlikely to be sufficient to satisfy all of the outstanding mortgage debt. This reality has a ripple effect on the mortgage-backed security, ultimately causing financial harm to the investors buying the bundled mortgages.
The Federal Home Loan Mortgage Corporation, commonly referred to as “Freddie Mac,” and the Federal National Mortgage Association, commonly referred to as “Fannie Mae,” both compete on the secondary mortgage market, which is the market for the sale of securities or bonds collateralized by the value of mortgage loans. In short, they both package mortgages into mortgage-backed securities for sale to investors on the secondary mortgage market. Both Fannie Mae and Freddie Mac have requirements which must be met before they will buy a mortgage from a local lender, which they appropriately refer to as the “seller.” The Fannie Mae and Freddie Mac requirements placed on the seller (meaning, the local lender) trickle down to and then must be met by the association. The association’s compliance with these requirements is then analyzed by the local lender and likely further analyzed by Fannie Mae or Freddie Mac as a part of its bundled loan purchase.
The mortgages they purchase help ensure that home buyers and investors who purchase property have a steady and stable supply of mortgage money. They broaden the likelihood of funds being made available for housing by attracting new secondary mortgage market investors through offering packaged mortgage-backed securities and guaranteeing the timely payment of principal and interest on the underlying mortgages. This makes secondary mortgage markets more liquid and can help lower interest rates paid by the actual mortgage borrowers (i.e., the property purchasers). It is reported that at times, together they finance up to 90 percent of all residential mortgages. Without Freddie Mac and Fannie Mae buying mortgages from lenders, the lenders would not be in a position to continue to offer loans. They need the funds from the Freddie Mac or Fannie Mae purchase to have available funds to make new loans. The bottom line is that if you expect purchasers in your condominium to be able to obtain a loan, then ultimately your association will have to abide by their requirements, including their demand for information about your condominium building’s condition and the condominium association’s finances, which are set out in their similar questionnaires.
Congress created Fannie Mae in 1938 to provide accessible funding and more affordable housing. Freddie Mac, alternatively, started in 1970 as a public enterprise to further expand the secondary mortgage market. While there are many similarities between Fannie Mae and Freddie Mac, there are some key distinctions. The significant difference between Freddie Mac and Fannie Mae is where they acquire their mortgages. Fannie Mae purchases mortgages from larger, commercial banks, while Freddie Mac buys them from much smaller banks. While Fannie Mae and Freddie Mac programs have some differences in lending requirements, these requirements also appear more similar than different in so far as they assure the lender they will buy the loan.
As a result of the Champlain Towers South collapse, Fannie Mae and Freddie Mac have imposed new temporary, additional requirements for mortgages obtained for condominiums and cooperative residential units. These new additional requirements will make it harder for existing condominium unit owners to refinance and for new buyers of condominium units to obtain mortgages.
On October 13, 2021, Fannie Mae issued Lender Letter LL-2021-14 entitled “Temporary Requirements for Condo and Co-op Projects,” resulting with a new questionnaire effective January 1, 2022. In so doing, Fannie Mae suspended flexibility that allowed a lender to obtain a reserve study in lieu of meeting the 10 percent budget reserve requirement. Simply put, this means that if an association does not reserve at least 10 percent of its total annual budget for reserves, then any lender working with Fannie Mae will not be in a position to issue a loan to anyone purchasing a unit in that association’s condominium because doing so would make that loan ineligible for purchase by Fannie Mae, which ultimately hurts the local lender because it will have less funds to loan.
Moreover, Fannie Mae will no longer issue project eligibility waivers for significant deferred maintenance or for projects subject to large special assessments. In other words, if the condominium association is not contributing at least 10 percent of its annual budget into the reserves, then Fannie Mae will not buy the loan from the local lender, meaning that the local lender will most likely not issue the loan to the buyer. In addition, and as part of its 10 percent reserve requirement, Fannie Mae no longer allows a borrower to rely on a reserve contribution provided in a reserve study in lieu of meeting the requirement that 10 percent of the annual assessments be contributed to reserves. Therefore, Freddie Mac-backed loans will become even more important to purchasers of condominium units and the developers who build them.
Then, on December 15, 2021, Freddie Mac issued Bulletin 2021–38 entitled “Temporary Condominium and Cooperative Project Requirements and Topic 5600 Reorganization,” effective February 28, 2022 (the “Bulletin”). While Freddie Mac has strict requirements, too, it is not strictly requiring that 10 percent of the association’s budget be allocated to the association’s reserves. The Bulletin begins with the following statement of fact:
In the aftermath of the collapse of the Champlain Towers South in Surfside, Florida, the risks of residential buildings with aging infrastructure and in need of Critical Repairs have been brought to the forefront of discussion throughout the nation.
Regarding reserves, local lenders may continue to rely on a working capital fund for new condominium projects or a reserve study for both established and new condominium projects when the project’s budget provides less than 10 percent replacement reserves. In other words, as so succinctly explained by a regular reader of Rembaum’s Association Roundup, Barry Subkow, Esq.,
Unlike Fannie Mae, if the contribution to reserves is less than 10% of the total annual assessments (e.g., 8%) and is based on the reserve contribution amount that is provided in a reserve study, Freddie Mac will allow the loan.
These newest Freddie Mac temporary requirements apply to all mortgages secured by units in projects with five or more attached units and are in addition to, and do not supersede, any of the other existing current applicable requirements. As such, there are terms which every board member and manager should become familiar with as they are needed to complete the required questionnaires. For example, a loan given by a local lender to a buyer for a project in need of “critical repairs” (as defined below) is not eligible for sale to Freddie Mac. As a result, the local lender will not be inclined to make the loan if a governmental program entity, such as Freddie Mac, is not willing to buy the loan.
Because Freddie Mac secured mortgages are likely to become even more important in today’s economy, there are four terms with which every board member and manager should be familiar:
The term “critical repairs” refers to repairs and replacements that significantly impact the safety, soundness, structural integrity, or habitability of the project’s building(s) and/or that impact unit values, financial viability, or marketability of the project. These repairs and replacements include the following:
The term “material deficiencies” is defined as unresolved problems that cannot reasonably be addressed by normal operation or routine maintenance and which include the following:
The term “significant deferred maintenance” is defined as the postponement of normal maintenance, which cannot reasonably be resolved by normal operations or routine maintenance, and which may result in any of the following:
The term “routine repairs and maintenance” is defined as repairs and maintenance that are expected to be completed by the project in the normal course of business and are nominal in cost. These repairs are not considered to be critical and include the following types of work:
Any documentation used by the local lender to determine the eligibility of projects in need of critical repairs must be retained and provided to Freddie Mac upon request. Violations of state or local law, ordinance, or code, as referenced in the critical repairs definition, include failure by the association to schedule an inspection required by the applicable jurisdiction and any directive from a regulatory authority or inspection agency to make critical repairs. Projects in need of critical repairs remain ineligible until the required repairs and/or inspection report have been completed and documented. Sellers of the proposed loan (i.e., the local lender) must review an engineer’s report, or substantially similar document, to determine that the repairs resolved the building’s safety, soundness, structural integrity, or habitability concerns. Acceptable sources of documentation to determine if a project is in need of critical repairs may include but are not limited to the following:
The Freddie Mac restrictions on the purchase of loans from lenders does not apply to the following:
When determining if a repair is a routine repair or maintenance, Freddie Mac reminds the local lender that its condominium project budget requirements include determining that appropriate assessments are established to manage the project and that there are appropriate allocations for line items pertinent to the type and status of the condominium project. Sellers (meaning, the local lender) should evaluate the line items on the budget, especially those for repairs and maintenance, and the amounts associated with those line items as part of the seller’s project review process.
Regarding any current special assessment, even if paid in full for the subject unit, such special assessment must be reviewed to determine eligibility. This includes any special assessment that the board approved and, if required, owners approved, but the board has not initiated collection yet (e.g., a planned special assessment). The local lender must determine the following:
To determine that the amount budgeted to be collected year-to-date (YTD) has been collected, the following criteria apply:
Any documentation used to determine the eligibility of the special assessment, such as the income statement referenced above, must be retained by the local lender and provided to Freddie Mac upon request. In addition, special assessments with more than 10 monthly payments remaining must be included in the calculation of the monthly housing expense-to-income ratio and must be documented.
If a seller (the local lender) relies on a reserve study, then the seller must ensure the reserve study meets certain requirements, which include, but are not limited to the following:
Freddie Mac advises its sellers (the local lender) to evaluate the reserve study’s financial analysis. Sellers should compare, for the current fiscal year, the estimated beginning of the year (BOY) reserve fund balance in the reserve study to the actual BOY reserve fund balance. The reserve study’s recommended reserve allocation for the current fiscal year correlates to the project starting the year with that estimated reserve fund balance. If the project started the year with significantly less than what was estimated, then the project has likely failed to appropriately allocate the recommended reserve funds to provide the condominium project with sufficient financial protection.
If your association is not Freddie Mac eligible under these terms, then a local lender can submit a project waiver request (PWR), which, however, has many other strict requirements that are not further discussed herein.
The Freddie Mac Bulletin can be found at https://guide.freddiemac.com/app/guide/bulletin/2021-38.
The Fannie Mae Bulletin can be found at https://singlefamily.fanniemae.com/media/29411/display.
Each association will need to coordinate completion of the Freddie Mac and Fannie Mae questionnaires with its board members, manager, and, importantly, the association’s attorney. Practically speaking, the questionnaires will need to be updated as the scenario at your association changes. Just because an association is not eligible this year does not mean circumstances will not change leading to a later acceptance. As to the costs associated with the completion of the questionnaires (and while arguments may exist for the buyer who caused the need for the completion of the questionnaire to pay for it), since the questionnaire benefits the entire association by providing for a viable market for all new purchasers to acquire loans to purchase a unit, the expense should be deemed a common expense shared by all members of the association.
Be sure to reach out to your association’s attorney to answer any questions you may have regarding Fannie Mae and Freddie Mac questionnaires and their local lender requirements because, remember, if Fannie Mae or Freddie Mac will not buy the loan from the local lender, the lender is not likely to make the loan.
Partner, Kaye Bender Rembaum
Attorney Jeffrey Rembaum has considerable experience representing countless community associations that include condominium, homeowner, commercial, and cooperative associations throughout Florida. He is a board certified specialist in condominium and planned development law and is a Florida Supreme Court circuit civil mediator. Every year since 2012, Mr. Rembaum has been inducted into the Florida Super Lawyers. He was twice awarded as a member of Florida Trend’s Legal Elite. Kaye Bender Rembaum, P.L., is devoted to the representation of community and commercial associations throughout Florida with offices in Palm Beach, Broward, and Hillsborough counties (and Miami-Dade by appointment). For more information, visit kbrlegal.com.