Question: Our condominium is in trouble. Many of our owners obtained those “favorable” interest only rates a couple of years ago, and now that their monthly payment has increased, their units are being foreclosed upon. This is putting a burden on the rest of us, since those owners are no longer paying their condominium fees. We are a small association with a tight budget. The developer left us with very little reserves, and now we are struggling to keep alive financially. What should we do?
Answer: You have raised a serious question, which unfortunately not too many people are focusing upon. There has been a lot of press about the increasing foreclosure rate, and how that impacts on homeowners.
But you are describing the “ripple” effect that foreclosures have on the rest of the community.
Let's go back a few years. The real estate market was hot. Condominium developers were selling units faster than they could build them. Lenders were making what everyone perceived were very favorable loans -- namely 100 percent financing with interest only financing. And many developers not only low-balled the proposed budgets for the condominium association -- so as to keep the condominium fees low -- but also did not pay any money into a reserve account for the units which were still unsold.
Now, there has been a significant reversal. Prices of condominium units have either stayed stable or have decreased in value, especially where developers were forced to lower prices in order to sell their remaining units.
And those owners who are now faced with higher mortgage payments are being forced into foreclosure, and thus are not paying either their monthly mortgage or their condominium fees.
Every year, the Board of Directors of a community association is required to prepare a budget for the next fiscal year. They estimate the expenses which the association will have to pay, which includes such items as insurance, utility bills, management and legal fees and ordinary repairs. They also obtain a reserve analysis study which projects what costs they will have in the future to repair or replace such major items as elevators, roofs, walkways, and other common elements.
All of these costs must be offset by income, and in most cases the only source of revenues will come from the owners themselves.
Board members are elected and -- like any other elected officials -- are reluctant to raise taxes or increase association fees. So most association budgets are quite tight; they rely on the hope that all of the association owners will promptly and regularly pay their fees.
So if several owners suddenly stop paying, this will usually create a shortfall for the association. And that means that the bills which regularly must be paid -- such as utilities, insurance, or repairs -- will be deferred or not paid at all.
What alternatives are there?
First, the association can enact a special assessment, forcing all owners to pay more money, either monthly or as a one-time payment. Obviously, these funds will only come from those who are not facing foreclosure, but again the ripple effect may cause even more owners to become delinquent if they cannot afford those additional fees.
Ultimately, the association might have to “bite the bullet” and file for bankruptcy. I have been reading that more and more associations are, in fact, already contemplating such a drastic measure.
Next, the association can adopt and enforce a zero tolerance rule. If a unit owner is delinquent for more than one month, begin legal action against that owner. Don't let the amount of the unpaid fees get so high that there is absolutely no way that the owner will ever be able to repay.
I also have three long-term recommendations.
First, mount a strong political campaign to convince your State legislature to enact what is known as a “super lien”. This means that should a lender foreclose on a condominium unit, it would be required to pay the association X number of months back condominium fees.
In the District of Columbia, for example, if a lender forecloses on a mortgage which was recorded on land records after March 7, 1991, and if the foreclosed-upon owner was also delinquent in paying condominium fees, the lender is required to pay the association up to six months of these delinquent expenses.
The specific language in the DC Code reads as follows:
The lien shall also be prior to a mortgage or deed of trust ... recorded after March 7, 1991, to the extent of the common expense assessments based on the periodic budget adopted by the unit owners' association which would have become due in the absence of acceleration during the 6 months immediately preceding institution of an action to enforce the lien. ... (§42-1903.13(a)(2).
A similar provision has been proposed in the Maryland legislature, but the bankers have strongly -- and successfully thus far -- opposed its enactment.
If associations do not have enough money to carry on its operations, the property will go to waste and more and more owners will stop paying their association fees as well as their monthly mortgage payments. Clearly, that will only lead to more foreclosures, and more depressed areas.
The law has worked successfully in the District since 1991. Lenders have not gone out of business, as the opponents have been telling the legislators. More importantly, if a potential buyer at a foreclosure sale sees that the association is solvent, this will encourage competition at those sales, which will enure to the benefit of everyone, including the lenders.
In my opinion, the “super lien” must be enacted all over this country as soon as possible.
Escrow Three Months Condominium Fees
If you live in a cooperative, you may be obligated to put three months assessment fees in escrow. If you become delinquent, the cooperative has a cushion they can tap into, before they have to take legal action for collect or foreclose.
Condominium boards of directors should give serious thought to adopting this policy for their associations. Depending on your legal documents, the board may have the authority to do this on its own, or get the membership to vote to amend the bylaws.
Either way, this will assist in keeping the financial ship of state floating, for at least a few more months.
Right To Approve New Owners
My third recommendation is that associations should consider amending their legal documents to incorporate the right of the Board of Directors to approve potential owners. Such a right currently exists with most Cooperative housing complexes.
If you want to purchase a cooperative apartment, you usually must meet with the Board of Directors (or its Admission committee) who will determine whether you can be approved to become a member of the cooperative. The Board (or committee) will consider only two factors: is the potential owner (1) willing and capable of complying with the rules and regulations of the association, and (2) financially able to pay the monthly assessments.
Obviously, such a process if fraught with risk. If the person is rejected, they may claim discrimination, based on such issues as race, religion, sexual preference, etc. Nevertheless, over the years, since most boards (or committees) are conscientious and objective, there have been very few such complaints, despite hundreds (if not thousands) of such interviews with potential homeowners.
To my knowledge, although it is legal for a community association to adopt such an approval process, very few associations have done so. Perhaps it is time to consider this option. If the lenders will not screen their borrowers, why should a community association have to suffer by having a new owner who will not be able to meet his/her financial obligations to the association?
I fully recognize that this is a drastic and controversial proposal. I certainly do not want to restrict anyone from home ownership. But on the other hand, I cannot accept the fact that potential owners may ultimately not only hurt themselves, but the community in which they live.
It's food for thought.