What is a Non-Warrantable Condo
Go Back To Previous PageThe real estate market is a complex maze of opportunities, with condominiums forming a distinct part. They provide the benefits of homeownership while relieving owners of the responsibilities of maintaining a single-family home. Yet, the journey toward condo ownership includes challenges. One significant obstacle is the issue of non-warrantable condos.
Unraveling the Concept of Non-Warrantable Condos
A non-warrantable condo refers to a condo unit that fails to meet the criteria set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. These GSEs
ensure the housing market’s stability by bulk purchasing mortgage loans and repackaging them into mortgage-backed securities for sale in the secondary market. This method enables lenders to provide more bank loans without keeping the debt on their balance sheets.
The GSEs impose strict standards to reduce risks that might render the debt more dangerous for investors.
If a condominium fails to meet these criteria, it is labeled non-warrantable, signaling elevated risk for the lender.
Most lenders rely on the GSEs to back their mortgage debt and investors to acquire it.
Therefore, obtaining traditional financing for a non-warrantable condo remains difficult.
There are four common reasons why a condominium building may be classified as non-warrantable.
- The building ownership is concentrated with a few owners
- The building units are mostly rental
- The building lacks cash reserves
- The building is involved in litigation
Building ownership
A key characteristic of a non-warrantable condo is its ownership structure. If one entity owns more than 20 percent of the individual units in a complex, the building is typically classified as non-warrantable. High ownership concentrations can pose a risk to lenders, as the financial stability of the condo community may be overly reliant on a single owner or a small group of owners.
Occupancy types
Another risk factor in condos is the collective occupancy of the building. If most units are investment properties or rental units, the condo may be classified as non-warrantable. Lenders perceive rental properties as higher risk because they may not be maintained as well as owner-occupied units. If the owner of an investment property encounters financial difficulties, they may sell the unit at a discount, which could negatively impact other unit owners.
Financial reserves
When a condo building seeks warrantability approval, its budget and financial health are reviewed.
A condo may be considered non-warrantable if the homeowners association (HOA) does not set aside at least 10 percent of its dues for a reserve fund designated for maintenance and emergencies. Additionally, if more than 15 percent of the units are at least 60 days overdue on their assessments, the condo may also be classified as non-warrantable.
Legal risk
A condo building may be classified as non-warrantable if the condo complex or its developer is involved in litigation. However, active or pending legal issues do not automatically disqualify condo buildings from warrantability, especially if the legal matters are unrelated to the building’s safety, structural integrity, or habitability.
Securing Financing
Securing financing for a non-warrantable condominium is challenging yet achievable. Local banks, which typically retain their mortgages instead of selling them on the secondary market, may place less emphasis on GSE approval.
Working with a realtor or mortgage broker who understands those is beneficial.
They can provide insights into the building’s warrantability and connect you with lenders willing to offer mortgages.
The Implications of Buying a Non-Warrantable Condo
Buying a non-warrantable condo is practical if you recognize the risks involved.
It doesn’t automatically mean it’s a poor investment.
You might find a more competitive price since developers and sellers know the financing difficulties. However, it’s essential to understand the reasons behind the condo’s non-warrantable status and how it could affect your experience as a homeowner.
For example, understanding the reasons and potential consequences is vital if the HOA is currently in litigation. If the building is in construction, knowing the anticipated completion date and its impact on your enjoyment of the property is essential.
Additionally, you should be ready to invest additional effort to obtain financing.
In South Florida, many newly constructed condo buildings often face litigation against the developer due to alleged construction defects. This situation is quite common, and since there is generally only potential benefit if the case is resolved favorably, such litigation should not be seen solely in a negative light, except for the ongoing legal fees until the issue is settled.
The Significance of Non-Warrantable Condos and Warrant of Habitability
It is vital to understand that non-warrantable condos are not connected to a warrant of habitability. Typically, this warrant relates to local housing department certifications verifying a property’s occupancy safety.
Obtaining a warrant of habitability is often more vital. Without it, your local housing agency could deem the property uninhabitable until any unsafe Conditions are addressed.
Another critical aspect is that banks may need to retain these loans on their balance sheets due to their lack of guarantees from GSEs.
This situation requires more capital and makes these assets relatively costlier to hold. In contrast, conforming mortgages, backed by GSE guarantees, can be quickly packaged and sold to third-party investors through mechanisms like mortgage-backed securities.
Bottom Line
Although non-warrantable condos don’t meet GSE requirements, they are not inherently flawed or defective.
There may be valid reasons for a condo’s non-warrantable status, and the property can still be excellent.
However, before buying a non-warrantable condo, it’s essential to understand the reasoning behind its status and be ready to take a few extra steps to secure financing.
Georges has been working in Wall Street for the last 16 years trading derivatives with hedge funds. He has been an active real estate investor for over a decade. Georges graduated from HEC Business School in Paris and holds a master in Finance from ESADE Barcelona.
