April 2nd 2010
Buyers today are no strangers to the many time delays they face in getting to the closing table, particularly due to the difficulties in obtaining a mortgage. Whether with respect to a co-op, condo or new developments, it seems there is a new hoop through which to jump each and every day. I thought I would outline therefore the reasons behind this market circumstance for buyers, sellers and agents alike, in the hopes of making this very real issue a bit more transparent.
The FHA (Federal Housing Authority) was created by the U S government in 1938 during the Great Depression to facilitate liquidity within the U.S. market place by insuring loans made by FHA approved lenders across the U.S. This insurance encourages lenders to extend credit to a broader class of borrowers (primarily lower and middle income borrowers) because they can bundle the resulting loans and sell them off, either to the Government Sponsored Enterprises (GSEs) or in the secondary market to commercial investors. The three most famous GSEs are:
• Freddie Mac: Federal Home Loan Mortgage Group
• Fannie Mae: Federal National Mortgage Association
• Ginnie Mae: Government National Mortgage Association.
Each of these entities purchases new mortgages from approved mortgage lenders who meet FHA criteria, providing the peace of mind that lenders need to continue the process.
As a result of the 2008/2009 housing crisis, many banks stopped underwriting and issuing mortgages until the FHA was forced to step into the abyss and purchase all newly issued confirming home mortgages from approved lenders. This enabled approved lenders to once again bundle conforming mortgages and sell them off to the GSEs, who in turn sold them to the Federal Reserve, now holding the mortgages. (Note: as of mid-March, the Fed purchased $169bn of a $175bn target of debt guaranteed primarily by Fannie and Freddie, which are ultimately guaranteed by the US Government.)
The Issue at Hand
So far, so good, right? Not so fast. The current problem for home buyers is that the FHA will insure only those loans “that meet their FHA Requirements”. Those requirements have been tightening, driven by national guidelines versus NYC-specific ones. Over the years, this had resulted in many NYC building falling short of meeting these requirements, and subsequently not being strictly enforced because we were in the boom years. Banks found very willing investors for these mortgage bundles from investors, thereby bypassing Fannie and Freddie altogether. No longer. Today Fannie and Freddie are largely the only game in town.
Devil is in the Details
Both Fannie and Freddie have tightened the regulations that govern the loans that they may buy from vendors. Even well qualified buyers can be denied a mortgage if their building of choice is considered a risk. Here are some of the pieces of increased scrutiny:
• All buildings now need Replacement Cost Insurance meeting fair value estimates. (Previously, they were able to get by with under-insuring themselves due to the high associated cost of the policy.)
• Insurance must be underwritten by a company rated “A” or better according to AM Best rating guide.
• Fidelity Bonds must be deemed as supplying adequate coverage to meet current financing guide lines. (These are issued to insure against employee dishonesty in buildings with 20+ units.)
• Flood insurance is required (yes, in Manhattan) for NYC Flood Zones: Battery Park City, Murray Hill, and areas along Canal Street.
• New I.R.S. guidelines require that less than 20% of the square footage of a building can be commercial space for those respective mortgages to be purchased by the GSEs (hotels or doctors’ office space are excluded).
• New regulations require both condos and co-ops to have 10% replacement reserves that are line item budgeted for deferred maintenance costs. Otherwise lenders will turn to their balance sheets to determine if there are adequate liquid assets, allowing for the filing of a building exception from Fannie and Freddie regulations.
Noteworthy among the consequences of new and more stringent guidelines is the complete lack of lending in Battery Park City. A letter from Fannie noted that the agency has temporarily ceased accepting loans in the Battery Park area while it reviews the ground leases there. Traditionally, only major New York lending banks have had the ability to make loans in buildings with land leases, with second tier banks struggling. This latest development has lead to BPC sales being down 76% since October 2009.
All of the above is meant to shed some light on the ever-changing world of home financing. Until the housing market finds sustainably sound footing, expect continued high levels of scrutiny from lenders and agencies, alike … meaning that buyers and sellers should brace themselves for the consequences of these tight credit markets in the near-term.