Changing Perspectives on Community Association Mortgage Underwriting and Credit Analysis

Title: Changing Perspectives on Community Association Mortgage Underwriting and Credit Analysis

Date: 11/1/2001

Author(s): Clifford J. Treese, Robert M. Diamond, and Katherine N. Rosenberry.

Executive Summary:

This Institute Report raises some important issues that do not typically receive much attention. In the ever changing world of mortgage origination and servicing, great strides have been made in improving the efficiency of the lending process for mortgages on both single-family and multifamily properties. As Mr. Treese, Mr. Diamond, and Professor Rosenberry point out, one area has been largely left behind-the role of community associations.

Community associations come in several forms: cooperatives, condominums, and planned communities. All have the common attribute that they have the power to conduct business and governance functions of the community. Moreover, they all have lien powers to collect the funds necessary to conduct that business and to require that residents conform to community rules. As the authors point out, the typical community association deals with an increasing functionality. The economic investment that homeowners have made in the units under the community association's umbrella is often highly dependent on how well the community association executes these functions.

The Institute Report is designed to fulfill two functions. The role of community associations in housing and mortgage markets is not well understood. Thus, the report lays out the basics of what community associations are and what they do. Particularly interesting is the trend for such entities to be assigned responsibilities for services that typically have been provided by local governments. This and other factors have led, according to the authors, to a rapid increase in the number of homes that are now part of one of the three forms of community association.

The growth in the number and scope of community associations has real implications for mortgage lenders. This is the second issue addressed by the report. The liens that they have on the homes in their community may be exercised, directly affecting the status of the first mortgage on the homes. In addition, increasing assessments or physical deterioration of the community infrastructure resulting from the actions of a poorly run association would be of vital interest to the holders of the mortgages on the individual units in the community. A community association can increase the risks of delinquency and default, either by putting an undue financial burden on the homeowners or by adversely affecting the value of the homes in the community.

The report concludes by addressing the issue of how information systems for community associations can better serve the lending community and borrowers alike. Progress on this front would mean lower transaction costs in terms of both time and money. It also would allow for more efficient and equitable pricing of loans by providing the information necessary for accurate risk-based loan pricing appropriate for mortgages on homes in either a poorly run or well-managed community association.

While many think of community associations as restrictive and favoring high-income homeowners, the authors maintain that this view is too narrow. As the report points out, a more efficient market in mortgage lending to homes in community associations will facilitate the achievement of some of today's key policy goals. The community association structure is uniquely suited to high-density and mixed-income real estate developments -key elements of both policies targeted toward smart growth and expanding homeownership to low-income and minority communities.