The Federal Housing Administration (FHA) insures mortgages used to purchase or refinance townhomes. However, not all townhomes meet FHA eligibility guidelines. Many townhomes are classified as single-family homes, in which case the FHA treats the properties the same way it treats standard houses. However, if the legal description of a townhome describes it as a condo, then the owner may not qualify for an FHA-backed loan.
People can take out FHA loans to buy homes with a down payment of just 3.5 percent. The FHA also insures refinance loans for homeowners refinancing existing FHA-backed loans into mortgages with lower interest rates. Homeowners can also borrow cash-out refinance mortgages insured by the FHA. Lenders require borrowers to have at least 20 percent equity in a home in order to take out a conventional cash-out refinance loan, but the FHA enables homeowners to borrow up to 85 percent of the value of a home.
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The FHA only insures townhomes classified as condos if the townhome complex as a whole gains FHA approval. Lenders must complete a condo questionnaire to determine if a project meets FHA guidelines. If a project qualifies based on the FHA criteria, the lender processes the loan application and the FHA insures the loan. If the townhome does not meet FHA criteria, the lender can either approve the loan and seek mortgage insurance from another source or decline the application.
The FHA only insures loans on townhomes and condos if the complex contains two or more units. The townhome association must provide hazard and liability insurance, and buildings containing financed units cannot exceed four stories. Commercial enterprises cannot occupy more than 25 percent of the overall complex, and no individual can own more than 10 percent of the units in one complex. The FHA also requires that at least 50 percent of the units are owner-occupied and that no more than 15 percent of the property owners are delinquent on townhome association fees.
The FHA changes its requirements for condo financing from time to time, and townhome complexes are required to requalify for FHA financing whenever guidelines change. However, homeowners with existing mortgages are not impacted if a development loses its FHA-approved status unless they attempt to refinance with a new FHA loan. FHA guidelines for townhomes classed as condos are strict because of the risk that foreclosures of other condos in the complex could cause association dues to rise and property prices to fall.