Could some of the nearly 67 million Americans who live in communities governed by homeowner associations — condominiums, master-planned developments, cooperatives and others — face much tougher underwriting and higher interest rates when they apply for a mortgage?
That is the looming threat from the mortgage industry in areas where state laws give community associations so-called super-priority liens on dwellings whose owners have not paid their assessments.
Super-priority liens give a community association the power to initiate foreclosures and get first crack at the proceeds from the sale of a delinquent dwelling unit, ahead of the usual first-lien position held by the mortgage lender.
Twenty-two states plus the District of Columbia have authority for super liens on their books; California does not. However, all 50 states recognize homeowner association liens.
Homeowner associations argue that, like property taxes for local governments, assessments or dues on units fund the essential operations of the community. They are crucial to maintaining the community's buildings, roadways, parks, recreation centers and other amenities. When unit owners fail to make the payments, the shortfall must be made up by the rest of the owners, often through higher assessments.
When large numbers of unit owners default on their mortgages and stop paying their assessments, the financial stress on a community association's finances can become extreme.
In the wake of the housing bust and recession, many communities in Nevada were forced to hit remaining owners with large special assessments, as well as postpone essential maintenance work on elevators, roofs and key facilities, said Marilyn Brainard, former president of her association's board in a community outside Reno.
"It was very hard, very painful, especially in communities where many of the residents were seniors living on fixed incomes," said Brainard, who served on a statewide commission overseeing community associations.
Numerous communities were pushed to the brink of insolvency, common areas deteriorated and property values of homes plummeted.
The situation in Nevada, Florida and other states that suffered deeply after the bust was compounded, community association leaders said, by the unwillingness of lenders and investors who owned the mortgages on defaulted units to step in and pay assessments once it became clear that borrowers had moved out.
Worse yet, according to the Community Associations Institute, which represents 33,000 member associations and managers nationwide, lenders "dragged their feet on foreclosures for years, delaying the process that would give them legal and financial responsibility" to pay assessments on properties they essentially owned.
To ensure that community boards get to collect unpaid assessments, some state legislatures have given them the right to initiate foreclosures, after giving notice to lenders and loan servicers. Typically there is a limit on the amounts they can collect from the sale proceeds, say six to nine months of assessments.
Mortgage lenders and servicers said they are sympathetic to associations' need to collect delinquent assessments, but not at the price of their own collateral interests in mortgaged houses.
Last fall, the Nevada Supreme Court ruled that the lender's lien can be wiped out when owners' associations foreclose on delinquent units after providing notice and giving mortgage holders the opportunity to pay the delinquent assessments.
For example, if the amount of back assessments owed is $6,000 but the first mortgage on the property is in the hundreds of thousands of dollars, the house might be sold at foreclosure to a bargain-hunting buyer for the assessment amount plus fees, leaving the lender with huge losses.
That is unacceptable to the giants of the mortgage market — Fannie Mae and Freddie Mac — and to their conservator, the Federal Housing Finance Agency, which is contesting such foreclosures through litigation.
In testimony before the Nevada Legislature, the agency's general counsel, Alfred M. Pollard, also warned that if lenders' collateral rights can be extinguished by associations, consumers "may face challenges in securing a loan to buy a unit or refinance."
David Stevens, president of the Mortgage Bankers Assn., was more explicit: In states with super liens that can wipe out lenders' and investors' interests, he said, buyers could face higher loan fees, heftier down payments and time-consuming examinations of community association finances.
Some lenders have said they may reconsider whether to do business in communities affected by super liens.
Bottom line: This is likely to be fought out in courts and legislatures but could start affecting mortgage terms and availability in some areas if lenders judge the risks to be too high.