Buying a condominium works a little differently than buying a single-family home. When you purchase a condo, you purchase a unit within an area where everyone else owns a piece as well. You don’t have the final say in anything that happens in the common areas. In addition, if many unit owners default on their loan, it affects the value of your property. Because of this, some banks look at a condo purchase as riskier than the purchase of a single-family home. The good news is, though, the down payment rules are usually the same. Because many first-time homebuyers purchase a condo for their first home, it is good that a large down payment is not required.
The Higher the Better
That being said, the more money you put down on a condo purchase, the less risk you pose to the lender. This is the case for any type of loan on any property, though. A higher down payment usually equates to a lower interest rate. Because lenders look at condos as riskier than most other home types, you may pay a slightly higher interest rate if you put the minimum down payment down on the home. Many lenders charge as much as 0.125 to 0.25 higher on a condo loan. Right now, the minimum down payments are as follows:
- FHA – 3.5%
- VA – 0%
- USDA – 0%
- Conventional – 5%
These are the minimum required down payments; you are free to put more down on the home. It may entice the lender to approve your loan application if you do so. If nothing else, it could lower your interest rate slightly. Even 1/8th of a percentage point can save you a little money each month.
Good Credit and Stable Income
Because of the instability of condo financing, many lenders require that borrowers have good credit and stable income to purchase a condo. Good credit helps the lender know that you take your financial obligations seriously. Stable income shows the lender that you are not a “job hopper” and that you can handle your responsibilities. With stable income, you are more likely to be able to afford your loan in the future. On the other hand, if you have a sketchy employment history, you could end up without a loan approval because the combination of unstable employment and a condo purchase do not go well together.
Compensating Factors for a Condo Purchase
Everything else aside, lenders look at condos as risky business. Condominiums are often the first to decrease in value when the market starts to go down. They are also usually the last to improve in value when the market recovers. Because you only own a unit on joint land, everything is basically outside of your control. This means the upkeep of the exterior of the building as well as the condition of the common areas are outside of your control.
In order to make up for the risk condos pose, you need compensating factors. If you can put down a larger down payment than the minimum required, you are already a step ahead of the game. The more equity you have in the home, the more likely you are to make your payments on time. Let’s look at an example:
- Tim puts down just 5% on a $150,000 condo. This means he borrows 95% of the value of the home, or $142,500. Tim suddenly loses his job and cannot make his mortgage payments. Because he only has $7,500 invested in the condo, he walks away from the condo because he cannot make ends meet.
- John puts down 20% on a $150,000 condo. This means he borrows 80% of the value of the home, or $120,000. John also loses his job, but because he has $30,000 invested in the condo, he figures out a way to make his mortgage payments. He has to get help from his family, but he gets to keep the condo he has a significant investment in.
In addition to a larger down payment, if you have great credit, you show the lender that you are not a risk for default. The combination of great credit and a large down payment gives lenders the reassurance they need to lend you the money.
Another compensating factor that may work to your benefit is a low debt ratio. This may or may not affect your ability to secure a mortgage for a condo, but it may help. The fewer debts you have on your plate, the less likely it is that you will default on your mortgage.
The Role of the Association
Oftentimes, it is the condo association that prevents potential homebuyers from securing a mortgage on a condo. Almost every loan program has a condo questionnaire the association must complete. From there, the appropriate entity needs to approve the association. If certain factors prevent the development from securing approval, though, no one can secure financing in the building.
For example, for FHA financing, at least half of the units in the development must be owner occupied in order to secure financing. In addition, at least 70% of the units must be sold, if the development is new. For conventional financing, no more than 15% of the current homeowners can be late on their association dues and there cannot be any lawsuits against the development at the time of application.
Without approval of the association, the down payment on the condo will not matter, as no bank will provide funding.
A condo purchase is definitely a risky business, but it can be done. As is the case with any purchase, the more money you put down on it, the less risky you are to a lender. Any other positive factors you can supply a lender with will only positively impact your loan. Typically, the interest rate is where you will see the greatest impact as this is how the lender makes up for the riskiness of a loan. Condos are already known as high risk, so anything you can do to lower the risk will help you.