Should The FHA Insure Luxury Condo Loans?

Last week Senator Charles Schumer (D-NY) announced an effort to increase the size of FHA builder loan guarantees for new housing units in major cities. Now Bloomberg News is reporting that FHA loans are being used to finance the acquisition of luxury apartments in New York.

“The Federal Housing Administration agreed in March to insure mortgages for apartments at the 98-unit Gramercy Park development, known as Tempo. That enables buyers to make a down payment of as little as 3.5 percent in a building where apartments are listed at $820,000 to $3 million,” says Bloomberg. (See: Manhattan Luxury Condos Try FHA Backing in `Game Changer’, August 13, 2010)

Alas, the Bloomberg report seems to have set off some concern.

“Yes, ladies and gentlemen,” says Tyler Durden at ZeroHedge.com, “the FHA is now insuring purchases of ultra luxury appartment by the ultra rich, affording what is essentially a no money down ‘NINJA/subprime-like’ creep up into the most expensive properties in the world, entirely on the backs of the US middle class. If that ‘uber-wealthy’ don’t blow up the FHA, and the $7 trillion in GSE debt, nothing will.” (See: Rick Santelli Goes Nuts In A “Top 3” Rant Protesting (What Else) Endless Subsidies And Fed Meddling, August 13, 2010)

The New York Post tells us “the development features an outdoor movie theater, panoramic city views, apartments valued between $820,000 and $3 million — and, thanks to the government, the ability to land a mortgage with less than a $100,000 deposit.” (See: Luxury ‘$uite’ deals, Feds back condo mortgages for wealthy, August 14, 2010)

Golly, FHA loans for the super-rich sure sound like a horrid bit of financing. Unless, after all, you consider the entire story.

Cash Up Front

It turns out that for 2010 the FHA higher cost loan limit in the continental United States is $729,750. That means if you have property in what is defined as a “higher cost” area of the contiguous 48 states you can get an FHA mortgage for the aforementioned $729,750.

For most of us $729,750 is a big number. For a property that sold for $729,750 a purchaser would need $25,541.25 at closing just for the 3.5 percent FHA down payment. Closing costs are extra.

But, you’ll notice that Bloomberg did not say any of the luxury units actually sell for $729,750. They sell for more, from $820,000 to $3 million.

This is where the FHA gets sticky. You see the FHA has a thing about real estate purchases which are above the loan limit. The deal is this: when you buy with FHA financing you’re not allowed to have a simultaneous second loan unless it comes from a governmental agency. You have to pay any additional value above the mortgage in cash.

One of the caveats here is that after the property has been settled the FHA buyer/borrower can then get a second loan such as a home equity line of credit (HELOC). This is usually not a consideration with a property where someone put down 3.5%, but it’s a real possibility when the cash down is significant. Of course, when there’s a second loan the FHA mortgage remains in first place which means if there’s a foreclosure the proceeds from the sale of the property must be used to completely satisfy the first loan holder before the second lender gets a dime.

Bundles of Money Down

So, let’s take a look at those luxury units in Manhattan — or anywhere else. Buy one for $820,000 with 3.5 percent down and you’ll need $28,700 at settlement plus closing costs. Oh, but wait, the FHA loan limit is $729,750 so you’ll actually need $90,250 in cash for the closing down payment. That’s 11 percent down — more than three times the usual FHA down payment requirement.

As to the $3,000,000 unit the math looks like this: $729,750 in financing means the buyer will need an additional $2,270,250 in cash at settlement — plus closing costs. That’s a deal with 76 percent down and virtually no risk for the lender.

Or the FHA.

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