Why are rates higher on condos?
Question of the week: Why are rates higher for condos?
Answer: Risk.
Long time readers of the WR&MU know that when discussing rates, the conversation is usually about markets, investors, economy, and factors that cause rates to go up or down.
In this case we are talking about why is the rate different, all other factors being exactly the same with the exception of the type of dwelling; in this case condominiums. The question of the week has come up more often this year as with higher rates many prospective buyers are looking to purchase condos since they are generally more affordable than single family homes.
Early last year we covered “LLPAs” Loan Level Pricing Adjustments, fees that are added to base pricing by the Federal Housing Finance Agency that Fannie Mae and Freddie Mac must charge for certain factors in a mortgage application.
Most mortgage applicants are aware that the lower their credit score the higher their rate will be. Technically, it is not necessarily that the rate is higher for the lower score, but that the cost that Fannie/Freddie must charge is higher. Instead of charging more costs, i.e. points, most lenders offer a higher interest rate. (The higher the rate the lower to cost, or points; the lower the rate the higher the cost, or points.)
The LLPAs are an expression of risk to investors for certain aspects of a mortgage application, such as higher or lower credit score, higher or lower down payment, owner occupied or investment.
Risk is measured by late payment, defaults, and foreclosure rates. Each of the factors listed above, credit score, loan to value (i.e. how much down payment), occupancy of property, have measurable differences in risk—therefore variable costs on mortgages for those factors to compensate for the risk.
Another factor is the type of property that is the subject of the mortgage. The least risky type of property is a detached single-family residence (SFR). There are no LLPAs for an SFR. Significantly riskier, per historical payment data, are condominium units.
Why are they riskier?
When you purchase a home in a neighborhood, you are in a loose business relationship with your neighbors. If your neighbor has a run down home, lawn is weeds, dirt and the back seat of a 1982 AMC Gremlin, it will impact the value of your home.
When you purchase a condo, you are in an intimate business relationship with every other unit owner in your complex and homeowners’ association (HOA). The health of the HOA directly impacts the value of your unit.
Your neighbors, individually and collectively, make up the board of your HOA, they pay, or don’t pay, dues to the HOA, determine what capital improvements, maintenance and repairs are to be completed. All of these factors impact the financial health of HOAs, and therefore the value, or ability to sell, units in the complex.
If a 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 in regards to condo is that a large percentage of condos are converted to rental properties. I have had many clients over the years purchase a condo for their first home, then when they are able purchasing 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.
Finally, a new wrinkle for risk in California is the insurance issue. Many HOAs are losing their approval from Fannie/Freddie because they are underinsured for replacement values due to higher construction and labor costs. With insurance carriers leaving the state, HOAs trying to increase their coverages in order to be eligible for conforming financing, and those who have sufficient coverage but are renewing, are seeing significant increases in premiums. Which result in significant increase in HOA dues, which may make it challenging for all owners to pay their dues.
These factors above paint a negative picture for condominium purchases. However, the vast majority of condo complexes are well run, fiscally responsible and ideal properties for buyers—particularly first-time buyers. I paint the negative picture because these are factors lenders look at when assessing risk, and therefore rates.
How much higher are rates for condos over single family residences? If you are putting 30% or more down there is no difference in pricing (high down payments can eliminate most LLPAs). For most buyers looking between a condo and SFR, the rate difference with 20% down is about 0.25% (one-quarter of one percent), the difference with 10% down is about 0.375% (three-eighths of one percent). Add on the HOA to the rate difference and it may pencil out that you can afford a single-family residence after all. Contact me to run your numbers.
To schedule an initial meeting by phone or Zoom, click here for my calendar, please feel free to forward to a friend or family member!
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Rates for Friday September 8th, 2023 Markets back to traditional inverse movements, rates increase this week (lower prices) as stock markets go up. Not a lot of economic news that would cause major movements or trends—just traders chasing returns.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:
30-year conforming 7.125% Up 0.25%
30-year high-balance conforming 7.625% Up 0.125%
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.
It is that time of year when I plan most of my Sundays by looking to see if the Eagles will be on local television, and if not (usually the case) what time they kickoff, 10:00 or 1:00 our time. If not on television I will plan my yard work, and other chores, around their kickoff so I can listen to the great Eagles radio announcer Merrill Reese, with his sidekick and ex-Eagle wide receiver Mike Quick (yes, the perfect name for an All-Pro receiver), do the radio broadcast.
Of all the many great things internet, near the top of the list for me is being able to listen to radio broadcasts for all the major sports teams—particularly the Philadelphia Phillies and Eagles. I find I learn a lot more about the teams, players, and game listening to the radio announcers as they describe the action and fill in the time between plays, or at-bats, whereas television announcers can often take long pauses as their medium is visual and not auditory.
I’m an old guy with the modern version of a transistor (which I had well into late 20’s).
Go Birds!
Have a great week,
Dennis
Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog
