Deferred maintenance at forefront with revisions to lender questionnaires: how the secondary mortgage market is responding to surfside tragedy

DEFERRED MAINTENANCE AT FOREFRONT WITH REVISIONS TO LENDER QUESTIONNAIRES: HOW THE SECONDARY MORTGAGE MARKET IS RESPONDING TO SURFSIDE TRAGEDY

On October 13, 2021, the Federal National Mortgage Association (Fannie Mae) issued Lender Letter LL-2021-14 (“Lender Letter”), to take effect January 1, 2022. This Lender Letter temporarily revises the eligibility requirements for lenders issuing loans that may be purchased by Fannie Mae for properties located in condominiums containing five or more attached units. The Lender Letter was issued in response to the Surfside tragedy[1] and is aimed at mitigating the risks lenders and other industry stakeholders take when purchasing loans in the secondary mortgage market where the loan may be securing a unit in a building with structural defects that endanger the safety and security of the residents.

I “Deferred Maintenance” Under the Lender Letter

Under the Lender Letter, conditions that render a loan ineligible for purchase by Fannie Mae include evidence of significant deferred maintenance, as well as repair directives from a local regulatory authority or inspection agency directed towards repairs needed to resolve unsafe conditions. Special assessments and loans aimed at building components will be subject to further scrutiny under the Lender Letter.

An additional change from Fannie Mae’s prior criteria is that loans in projects with significant deferred maintenance, or that have received repair directives from a regulatory authority or inspection agency aimed at repairs needed to resolve unsafe conditions, are not eligible for purchase by Fannie Mae. The Lender Letter does not define “deferred maintenance” but it does include examples of what Fannie Mae’s criteria are for finding that a project has had significant deferred maintenance. These criteria include:

  1. Full or partial evacuation of the building to complete repairs for more than 7 days or an unknown period of time;
  2. (a) The project has deficiencies, defects, substantial damage or differed maintenance that: are severe enough to affect the safety, soundness, structural integrity, or habitability of the improvements; (b) the improvements need substantial repairs and rehabilitation, including many major components; or (c) the project’s deficiencies, defects, substantial damage or deferred maintenance impede the safe and sound functioning of one or more of the building’s major structural or mechanical elements (including foundation, roof, load bearing structures, electrical system, HVAC, or plumbing)

II. Instances That Are Not Considered “Deferred Maintenance”

    The Lender Letter mentions that its definition of “deferred maintenance” does not apply to routine maintenance, nor does it apply to situations where there is an isolated incident that affects one or a few units. The Lender Letter cites examples of a leaking pipe that is isolated or damage from a small fire that only affects the interior of a specific unit. The intent of Fannie Mae’s inquiry is aimed at the project as a whole and its overall safety, soundness, structural integrity and habitability.

    III. Additional Scrutiny Of Special Or Additional Assessments & Loans

    Along with these considerations, the Lender Letter imposes stricter eligibility standards if an association has levied special or additional assessments, or obtained a loan, to address deferred maintenance. The reason for the assessment or loan, the repayment amount and terms, along with a demonstration that there is no negative impact to the financial stability of the condominium are to be considered by Fannie Mae when reviewing a prospective homeowner’s loan. To the extent assessments were levied or loans obtained for these purposes, additional information and documentation will be sought to determine whether the loan is eligible for purchase by Fannie Mae.

    IV. Changes To Reserve Requirements

    In regards to reserves funds and reserve studies, the Lender Letter provides that Fannie Mae is suspending its practice of permitting an association’s reserve study to serve in place of its minimum budget reserve requirement and is instead strictly adhering to requiring 10% annual contribution. While it is possible to apply for an exception in established projects that have a reserve study that shows there is sufficient reserves, any requests for exceptions for new projects will not be considered by Fannie Mae. Previously, for loans to be eligible for purchase in the secondary market, the adequacy of reserve funding had been a key component of what the Federal Housing Administration (FHA), the Federal Mortgage Loan Corporation (Freddie Mac) and Fannie Mae looked for in determining whether or not to insure, issue or sell loans on residential condominiums. Not adequately funding reserves could restrict access to financing for new purchasers as well as existing owners who wish to refinance. Prior to the Lender Letter, 10% of the association’s assessment income was to be committed each year to the reserve account, unless the association has a reserve study not older than two (2) years showing that the association’s funding level equals or exceeds what is shown in the plan.

    V. Other Parties Adopting Similar Standards

    While Fannie Mae was the first to issue new directives aimed at deferred maintenance and the safety and habitability of the project, other players in the secondary mortgage market have been quick to adopt similar standards. In its Announcement 21-94, PennyMac announced they are aligning with the Lender Letter, effective for loan deliveries on or after December 1, 2021. Freddie Mac subsequently issued Bulletin 2021-38 adopting similar standards for mortgages with settlement dates on or after February 28, 2022.

    VI. New Addendums to Condominium Project Questionnaires

    Together, Fannie Mae and Freddie Mac developed Form 1076 and Form 476 (“Addendum”), respectively, which is an addendum to their Condominium Project Questionnaire. This Addendum addresses the criteria raised in the Lender Letter. The 12 questions included in the Addendum seeks information that speaks to the buildings’ safety, soundness, structural integrity and habitability. The initial inquiry asks about the last building inspection by a licensed architect, licensed engineer or any other building inspector and, if one was performed, whether that inspection yielded any findings related to the safety and habitability of the building. If the answer is “yes,” additional explanations must be given, along with copies of the inspection, the board meeting minutes relating to the inspection, the action plan and anticipated timeframe for completing the work. The Addendum also asks whether there has been a reserve study in the last three (3) years and whether there are: (1) any known deficiencies related to the safety and habitability of the buildings; (2) any outstanding violations of jurisdictional requirements; (3) any deferred maintenance, and if so, the schedule of when those components will be repaired or replaced; (4) any special assessments, and if so, the term and purpose of those assessments; or (6) any outstanding loans to finance improvements or deferred maintenance. With the changes incorporated in this Addendum, an in depth analysis of deferred maintenance in the project will be at the forefront for reviewing whether a loan will be eligible for purchase on the secondary mortgage market.

    The time to start evaluating these questions is now. Boards will need to carefully review their budgets and consult with necessary professionals, including property managers, attorneys, building engineers or building inspectors, to confirm whether the project has “deferred maintenance,” and to the extent it does, work to formulate a plan and timetable for addressing the same. The board may also want to consider obtaining a reserve study in the near future, as that is strongly encouraged in the Lender Letter and Addendum, and will assist the association in completing the Condominium Questionnaire.

    [1] Ninety-eight individual perished when a 12-story beachfront condominium located in Surfside, Florida partially collapsed on June 24, 2021.