Cooperative apartments need loans, too! Richard H. Lovell Esq.cooperative apartments, lending
Disclaimer: The information contained within this article is
for educational purposes only. Please check with your individual
state and local regulations before pursuing cooperative apartment
loans.
When I first wrote about cooperative apartments in The
Mortgage Press a few years ago, I received many requests for
additional information from the mortgage industry. Since I continue
to receive inquiries on this sometimes-puzzling subject, I decided
that it was time to publish a revised version of my previous
article. So here it is!
Most mortgage professionals know the ins and outs of securing a
mortgage loan on a one- to four-family house. Even a condominium
loan does not faze them. However, the mere mention of attempting to
obtain a loan on a cooperative apartment for a client can have the
most experienced professionals running for the hills of
misinformation and misunderstanding. The fact is this; some equate
the difficulty and confusion of obtaining a cooperative apartment
loan with obtaining a mortgage on Osama bin Laden's cave.
Well, it is quite true that the financing of cooperative
apartments is different than obtaining a mortgage for a house or
condominium unit. It is different because the loan is not being
secured by real property, as it is with other types of financing.
There is no mortgage document to file with the local county clerk
because a mortgage can only be filed against actual real property.
But we are getting ahead of ourselves. It's time to get to the
basics.
For our purposes, let us assume that obtaining financing on one-
to four-family houses and condominium apartments is the same. Yes,
there are differences, but not enough to make a broad-based
distinction. When we help a borrower obtain a mortgage on a house,
we do the usual things; we run a credit check, obtain a
verification of employment (VOE), appraisal and verification of
deposit (VOD), etc. Then, after the loan is approved and we obtain
a satisfactory title report, we go to closing. At the closing, the
borrower signs, among other documents, a mortgage and, in New York,
pays a mortgage tax and recording fees to have that mortgage
recorded at the county clerk's office in the county where the
property is located. Once the mortgage is properly recorded, the
lender has a valid security interest in the property. What does
this mean? The lender now has a lien against the borrower's house.
If the borrower does not pay his mortgage payments in accordance
with the terms agreed to, the lender may take legal steps to take
the house away from the borrower. This legal action is called a
foreclosure action. If the lender successfully completes the
foreclosure action, the borrower loses the house and the lender can
do with it as it wishes. The lender has the right to own the actual
physical property - the land, the dirt and the bricks and
mortar.
How cooperative apartments are different
Looking from the street, one cannot often differentiate between a
building containing cooperative apartments, rental apartments or
condominium apartments. The physical structure is not the defining
feature, as the differences are legal and not structural.
A cooperative apartment is located within a building owned by a
cooperative apartment corporation. This cooperative apartment
corporation owns the entire building (i.e., the land, the dirt and
the bricks and mortar). Most likely, this corporation has obtained
mortgage financing on the entire building. All of the apartments
within the building may be owned individually by apartment owners.
Some of the apartments may be owned by the corporation and rented
to tenants, perhaps due to the rules of various local rent control
laws. In any event, the units set aside for individual ownership
are sold to those interested in buying them. What is it, exactly,
that these purchasers are buying? We know that the purchaser of a
house or a condominium receives a deed to the property, which
indicates that he owns that piece of land upon which the house
sits. This is not true with a cooperative apartment! What the
cooperative apartment owner receives is not a deed, but a stock
certificate. This stock certificate is his evidence that he owns a
portion of the cooperative apartment corporation, which actually
owns the building (remember, the land, the dirt and the brick and
mortar). The unit owner gets a small piece of the cooperative
corporation, and, hopefully, it will remain more valuable than the
shares of stock held by the shareholders of Enron.
So, how do these differences affect the lending process? The
initial steps in the process are about the same (same credit
reports VOEs, VODs, etc). Then, however, the road takes a different
turn. Firstly, the monthly maintenance charges assessed by the
cooperative corporation must be added to the projected principal
and interest payments, to determine how much of a monthly
obligation a borrower can afford. Secondly, the building in which
the to-be-financed apartment is contained must be approved by the
lender. This means that the lender will have had to review the
financial statements of the cooperative apartment corporation and
make an independent determination that the corporation is
financially sound. If the lender has doubts about this financial
soundness, then the lender will probably not make a cooperative
apartment loan on an apartment in the building. (Of course, another
lender might be willing to lend on apartments in the particular
building, so sometimes, the mortgage broker has to shop
around.)
Don't forget the flip tax
A flip tax is not really a tax, in that it is not imposed by some
government entity. This is a charge imposed by many cooperative
corporations on the seller, usually in proportion to the number of
stock shares that the seller owns in the cooperative corporation.
This amount, if it exists, can be minimal or substantial. However,
if it is a charge paid by the seller, why should the borrower be
concerned about it? Firstly, a buyer/borrower should be concerned
because he will have to pay this charge when the apartment is sold.
It also can affect the cooperative apartment loan that the buyer
expects to obtain.
Let us estimate that the purchase price of the unit being
purchased is $100,000 and the borrower is seeking financing in the
amount of $80,000. This would make the loan-to-value (LTV) 80
percent, and private mortgage insurance (PMI) would not be
required. However, suppose in the case above, a flip tax were
imposed by the cooperative corporation upon the seller in the
amount of $5,000. For the purposes of computing LTV only, many
lenders would add this flip tax amount to the proposed loan amount
to determine the real LTV. Accordingly, in our example, the LTV
would be considered to be 85 percent and would thus very much
change the financing scenario. Perhaps PMI would be required or
other steps would have to be taken, to secure the financing.
Approval of the board of directors
Besides obtaining approval from the lender, the purchaser of a
house does not need approval by any other entity. The purchaser of
a condominium apartment does not need the approval of the building
manager or anyone else in order to proceed with the purchase of the
condominium unit. All that the condominium association can do to
prevent the purchaser from buying is purchase the unit directly
from the seller at the same price. (This is known as the right of
first refusal.) In practice, it is virtually unheard of for this to
happen. Again, however, things are very different with cooperative
apartments.
The cooperative apartment corporation is run by the board of
directors, who makes many of the decisions affecting the operation
of the entire building in which the apartment is contained. The
apartment owners elect the members of the board of directors. One
of the most important decisions made by the board is deciding who
will be allowed to own shares in the cooperative corporation (and,
accordingly, be allowed to purchase an apartment). Other things
that they will determine might include how much the purchaser will
be allowed to finance or how much an owner will be allowed to
refinance, if that is the owner's desire.
In order to make its determination, the borrower will usually
have to meet with the board (which might only meet once per month),
answer its questions, air his dirty laundry and provide the board
with personal financial statements or tax returns. Approval of the
purchase or refinance is at the sole discretion of the board of
directors and is certainly not guaranteed. The board can approve or
reject any borrower without explanation. It can also require
additional information and may not act on that information until
the following months board meeting. The board also usually sets
certain guidelines that may require a certain minimum down payment
(e.g., 25 percent is not uncommon). With these conditions in mind,
it is the wise mortgage professional who does not lock in an
interest rate on any cooperative apartment loan until the approval
of the board of directors has been granted.
The lien search
As part of the financing of a house or condominium, a title search
is performed and a report is presented to the lender (usually
through its closing attorney). Among other things, a title report
informs the parties who the actual owner of the property being
purchased is and whether or not there are any liens, judgments,
mortgages, etc. filed against the property or the parties. This is
important, of course, because any of these items can be an obstacle
to the new lenders property rights. At the closing, the borrower
typically purchases a title insurance policy to protect himself and
another to protect the mortgage lender.
With cooperative apartments, the search that is performed is
somewhat different. Recall that while one who purchases or owns a
house receives a deed stating that he actually owns the land upon
which the house sits, the owner of a cooperative apartment only
receives shares of stock in the cooperative apartment corporation.
Therefore, the search is different.
Firstly, we are interested in knowing if the cooperative
apartment corporation does actually own the land upon which the
entire building is located (e.g., if the deed to the building is in
the name of the cooperative corporation). It will also be revealed
if there are any liens or mortgages on the building itself (it is
normal and acceptable for a cooperative apartment building to be
mortgaged), if there are building violations issued against the
building and if the building has the proper certificate of
occupancy. We might be concerned if the cooperative apartment
corporation had large, unsatisfied judgments against it, hadn't
paid its real estate taxes in a long period of time or its mortgage
were in foreclosure. We'd want to know if the seller of the
apartment had any judgments against him or if the current owner had
used the stock certificate for the unit as collateral for a
cooperative apartment loan (information equally important to the
purchaser and new lender). These inquiries would also be applicable
to the borrower if a refinance and not a sale of the apartment were
contemplated.
The lender's attorney must be overly cautious in reviewing the
lien search, as the transaction does not usually include any sort
of title insurance, as is the case with a house or condominium.
Although an insurance policy on cooperative apartments is now
available from title companies in New York, most purchasers dont
elect to purchase one, and lenders don't require it.
A final word about the lien search: Don't take it for granted
that someone else has ordered it. On a refinance transaction, check
to see if anyone has ordered the search. While the search is
usually ordered by the buyer's attorney in a purchase transaction,
this, too, can sometimes fall through the cracks, as the
purchaser's attorney may believe that the lender is ordering
it.
The closing nears ... or so you might
think!
So we have obtained a loan commitment, we have the cooperative
apartment search and the board of directors has approved the
transaction. Now, you are ready to lock in the rate and set the
closing date, right? Not so fast! First, a few more details need to
be tended to. When you pay off a regular mortgage loan (either in a
purchase or a refinance transaction), a payoff letter is obtained
from the old lender and, at the closing, the title closer makes
arrangements to send the old lender the payoff check. Several weeks
later, the title company will receive a satisfaction of mortgage,
which will then be recorded with the appropriate county clerk.
However, satisfying a cooperative apartment loan that is presently
encumbering the shares of stock of a cooperative apartment is a
little more complicated and time consuming.
At the closing of the to-be-satisfied loan, the lender took and
retained the original stock certificate and proprietary lease for
the unit being financed. This lender is supposed to keep these
documents, to further secure its interest in the apartment. After
all, the lender cannot record a mortgage on the apartment, because
the apartment's ownership is only evidenced by shares of stock. It
is not real property, as is the case of a house (or the cooperative
building itself).
Now that the old lender is being paid off, not only do we have
to obtain a payoff letter from the old lender showing how much is
due to satisfy the current owners obligation, we must also make
arrangements to have the old lender deliver the stock certificate
and the proprietary lease back to the managing agent for the
cooperative corporation. This part of the process, unfortunately,
can take some time, depending upon the prior lender. This lender
must locate these documents, and this can sometimes take a few
weeks. (Usually, the seller's attorney is responsible for securing
these items. If it is a refinance, the mortgage broker or banker
should probably remind the borrower that this process must be
started.)
On a purchase, the agent for the old lender must come to the
closing to exchange the stock certificate and proprietary lease
(along with a UCC-3 Financing Statement Termination form) for a
payoff check. On a refinance, the old lender must come to the
closing attorney's office on disbursement day (e.g., after the
three-day right to cancel has expired) with the original stock
certificate and proprietary lease and a UCC-3 Financing Statement
Termination form. This UCC-3 form is to be recorded with the
appropriate county clerk, which effectively terminates the prior
lender's security interest in the stock certificate.
Ready to close now? Wait! Remember that the loan on a
cooperative apartment is not called a mortgage loan, because a
mortgage can only be given on real property (e.g., land). So, how
does a lender protect its interest in the cooperative apartment if
it cannot record a mortgage? How does the lender ensure that if the
borrower defaults on the payment of the loan to the lender, the
lender will be able to gain ownership of the stock shares? Besides
keeping actual custody of the stock certificate and proprietary
lease, the lender, usually via its closing attorney, must file a
UCC-1 Financing Statement (along with a cooperative apartment
addendum) with the appropriate county clerk prior to the closing.
While these documents are not signed by the borrower, the borrower
must sign an authentication letter, authorizing the lender to
actually file the UCC-1 form. The actual filing, depending upon the
county in which the cooperative apartment is located, can take from
one to several days. The reason that the UCC-1 must be filed prior
to the closing is that, for example, if a borrower were to file
bankruptcy between the time the loan were closed and the time that
the UCC-1 were filed, the lender would simply become an unsecured
creditor and might have to wait in line with everyone else to get
any money.
There is one more document that must be signed before a closing
can happenthe recognition agreement. This lender-required form,
simply put, requires that the managing agent for the cooperative
apartment not issue a replacement stock certificate nor a
proprietary lease for the apartment owned by the borrower unless
the managing agent is notified that the lender's interest in the
apartment has been satisfied (e.g., that the borrower's loan has
been paid off). This form is signed by the lender (usually by its
attorney) and the borrower and then sent to the managing agent for
the cooperative corporation. It must be signed by an officer of the
cooperative corporation and presented to the closing attorney at
the closing (or before).
The end ... almost
As this article threatens to get as long as the cooperative
apartment closing process itself, a few more items remain. While
most lenders whose loans are being paid off at a closing will
accept an attorney's escrow check for the payoff amount, most banks
whose cooperative apartment loans are being satisfied will require
either certified or official bank checks for the payoff amount.
This usually requires some advance notice to the closing attorney
by the seller's attorney. It should also be noted that there are
more schedules to coordinate to actually set the time and date of a
cooperative apartment closing. In addition to the usual parties,
the managing agent and the attorney for the payoff bank need to be
thrown into the mix.
While most lenders do not require the buyer to obtain
homeowner's insurance (unlike the purchase of a house), the lender
will require a copy of the cooperative corporations master
insurance policy on the building. A purchaser would be well
advised, however, to obtain his own cooperative apartment insurance
policy to protect valuables and provide for coverage in the event
someone is injured in the apartment. Some cooperative corporations
require the apartment owner to obtain this coverage.
To people (and lenders) outside of the downstate New York area,
cooperative apartment ownership and financing is puzzling at best.
Those of us who live here know that cooperative apartment ownership
in the New York metropolitan area is as common as beachfront
property in Malibu, Calif. A properly managed, fiscally responsible
cooperative apartment building can be a worthwhile investment and
afford a unique and often more affordable path to homeownership. It
sometimes requires just a little more patience.
Richard H. Lovell Esq. is the founder of Ozone Park,
N.Y.-based law firm Richard H. Lovell PC. He was a member of the New York Association of Mortgage
Brokers board of directors for more than 14 years. He may be
reached at (718) 835-9300 or e-mail
[email protected].
