In home buying, there are many options for the form of homeownership, each with different benefits and responsibilities, as well as effects on financing qualifications. Since condo HOA dues are included in a lenders calculation of home payment and maintenance/improvement costs of residential properties are not, qualifications for condominium purchase price will often be 5% to 10% lower (depending on homeowners dues) than your residential purchase price. This can be a very important factor in shopping for your next home, and knowing this difference can help you save a great deal of time and frustration.
Here's why the type of home you purchase will significantly impact the lender's view of your housing budget:
To keep things focus and as simple as possible, we won't dive too deeply into the special benefits and responsibilities of each type of ownership, rather will focus on the effects financing qualifications and budget. We will start with defining the major types of homeownership, then discuss what banks are looking for from borrowers and finish by demonstrating how this combination of homeownership and loan qualifications translates practically into the home buying and ownership experience.
Most Popular Types of HomeownershipResidential Houses – detached structures on a privately owned parcel of land. Owner is responsible for land and all structures on the land. While there may be a homeowners association or covenants which govern use of property and behavior in the neighborhood, the property owner is financially responsible for their property and its improvements (structures, outbuildings, etc.).
Residential Townhouses – attached structures on a privately owned parcel of land which may share a common wall(s) or other common structural elements with their neighbor. The residential form of ownership often means there is no "homeowners association" collecting periodic dues and managing the maintenance and capital improvements of the building. Rather, these residential townhomes most often have "joint maintenance agreements" recorded on the title which require owners within a building or community to maintain and make capital improvements to the building in set intervals or based upon specific conditions. Additionally, there may be shared elements between owners such as driveways, landscaping, yards, etc. where they are required to share responsibilities and costs of maintenance and improvement.
Condominium Homes – condominium homes can take many forms and styles including single level flat units, multilevel/townhome units and detached structures closely resembling houses on small lots. The major difference with the condominium, is the homeowner has exclusive ownership rights of their unit and shared ownership rights in the common elements of the community. Condominium homes almost always have a homeowners association which governs the common areas including collecting periodic dues to pay for the maintenance, capital improvements and other expenses of the community. In most cases, the homeowners association is responsible for maintenance of the exterior elements of the structure including the roof, siding, decks/patios, landscaping, driveways, etc. (with the exception of communities of "detached" single-family condos, where most often the owner of the detached houses responsible for maintaining all elements of the house).
There are other forms of ownership, and hybrids in between each of these major forms of ownership, which should be fully explored on a case-by-case basis. However these three forms of ownership cover the vast majority of all residential property purchases. Of course, there are plenty more nuances and details for each of these forms of ownership as well, and they should he be explored in detail with your broker as you navigate the purchase process.
Calculating Housing Payments
The key difference in lending between condos and residential properties in the inclusion of HOA Dues in your housing payment when calculating your debt to income ratio. Including HOA dues raises your DTI ratio for condos and therefore lowers your buying power if you are purchasing at the top end of your budget or approval. For more information on the key elements of mortgage approval, please visit this blog post.
Residential = Principal & Interest + Taxes + Insurance.
Condominium = Principal + Interest + Taxes + HOA Dues (+ Insurance)
*Many times lenders do not collect condominium owners insurance for their borrowers, as this only covers belongings & liability. The insurance to cover restoration of the building in case of fire or other catastrophic loss is covered within the homeowners dues, unless the owner is responsible for the maintenance and improvements of their structure.
Practical Example - House vs. Condo
Let's take a look at an example:
- Housing budget: $2500 per month
- Other Assumptions:
- Interest Rate: 4.75% on a 30 year fixed loan.
- Down Payment: 10%
- Insurance: $800/yr (Residential), $ 0(Condo; included in HOA Dues)
This example illustrates dramatic impact on buying power created by homeowners dues being factored into the housing payment of a borrower. The $400 homeowners dues decrease the buying power by $71,000 which means the home shopper with a $2500 budget for monthly payment, should be shopping for houses up to $518,000 and condos at $447,000, if they do not want to risk going over their monthly budget.
A few of other notes:
Higher down payment – because of the availability of a higher price point, residential buyers will often have a higher down payment simply because the purchase price is higher.
HOA Dues Pay for Maintenance and Capital Improvements – it's very important to note that HOA dues actually pay for the maintenance and capital improvements of the common areas of the community. The same costs are often realized by residential homeowners at similar levels, however they are not calculated in the overall underwriting criteria of loans therefore do not have an offset to your ability to qualify for monthly payment. As a guideline, we would encourage most homeowners to plan for approximately 1% of the value of their home for maintenance and capital improvement expenditures. So for the above example, at a purchase price of $518,000, we would encourage budgeting approximately $430 a month to help with everything from landscaping to the capital savings fund to replace the roof, paint the siding and do other major projects. When this type of long-term budgeting is factored in residential and condominium ownership tends to be equalized when viewed from a monthly housing cost perspective, especially when purchasing a condo in a well-run homeowners association.
Taxes - you'll notice that in the example I did not include property taxes. When looking at homes in reality, you'll certainly want to factor in property taxes to your monthly payment. However, trying to include property taxes creates a "circular reference" calculation where taxes are dependent on purchase price and vice versa making the monthly principal and interest payment very difficult to resolve (yes, I'm sure high-level math majors would have a solution for me), but for the purposes of this blog an explanation I thought I would try to keep it simple.
Hopefully this information is helpful in understanding your various options of homeownership and the effect on your budget, both from a loan qualification standpoint and a practical ownership perspective. We believe homeownership is a complex decision which can be made simpler with great consultation and counseling. We enjoy continuing the conversation with you and answer any specific questions you have, feel free to give us a call anytime.