Special Considerations for Co-op Special Assessments

The worst news most condo and co-op owners can hear is that their building is doing a reserve analysis and it appears that the building does not have enough money in reserve. What this means is that the building should have been saving more money (for necessary building repairs and improvements) and is now short. When this happens the building will need to levy a “special assessment” on owners to raise more money for repairs and improvements. This special assessment can range from just a couple of hundred dollars to well over $100,000 per owner!

When a special assessment comes due co-op owners are in a much better position to handle it than condo owners. That’s because cooperatives can take out an “underlying mortgage,” which means the co-op can mortgage itself as collateral for a loan. (Condos don’t have this option and the assessments usually have to be paid in one lump sum.) There are several nuances that a co-op owner must consider when they find out that their building is about to take out an underlying mortgage.

Generally, when a cooperative building finds that it is short on funds it will allow owners to either pay for the assessment in cash when it come due OR finance the assessment as part of an underlying mortgage (ULM). So, what should a co-op owner do?

If You’re Not Moving it Doesn’t Matter
If you are not moving during the course of the underlying mortgage (ULM) then it doesn’t really matter if you pay off the assessment or take out a ULM. Whatever meets your financial needs is fine. But, the reality is that most ULMs are at least 20 years and the odds are that you’re not going to move within 20 years. So it is important to consider the long-term consequences of your decision.

Should you pay off the special assessment?
Buyers are very sensitive to what the fee for a particular unit is. When a fee is very high the buyer will be less inclined to buy the home. Even when the fee is mostly comprised of a ULM the buyer will be less interested in the home because the buyer’s monthly holding costs will be higher.

Underlying Mortgages will generally have a higher interest rate than a regular “institutional” mortgage. That’s because the bank is generally making a loan that cannot be resold like a “regular” mortgage could.

So, if you own a co-op and have equity in the home, it may be better to get a “cash out” refinance than take the ULM. That means that you would get a whole new mortgage to pay off your existing mortgage and take out extra cash from your equity to pay off the special assessment. This will allow you to pay off the assessment over 30 years (instead of the usual 20 or few years) and have a lower interest rate; the lower rate and longer repayment mean you’re monthly payment will be lower than paying a ULM.

Or, if you have the cash available to pay off the assessment why would you pay interest on a ULM for 20 years? That’s a whole lot of interest on money that you don’t need to pay.

These points would indicate that an owner should pre-pay the assessment when possible. But things are not always what they seem.

Should you take the Underlying Mortgage?

Buildings get reputations for having high fees. Once a building gets that reputation agents and the public will not necessarily take the time to review what the fee for a building is. They’ll see the address and the photo of the building and dismiss it as having a high fee immediately.

This means, as an owner many agents and buyers will not take the time to read through information about a property to discover that the fee is actually lower than usual because the owner pre-paid the special assessment.

Even if the agents and buyers do look at the unit and discover that the fee is acceptable they will undervalue your home. That’s because they’ll look at the most recent sales in the building and compare your sale price with the prices of other units that have substantially higher fees. It’s hard to get agents and buyers to acknowledge that your unit is worth more money because the fee is lower when they see everything else sells for less.

Another consideration is that underlying mortgages are always assumable. So, with interest rates exceptionally low right now, you can lock in an assumable mortgage at a very low rate. In the future, when you sell the odds are very high that rates will be much higher than they are today. Thus, the underlying mortgage actually becomes a benefit! The next buyers can borrow money at a much lower rate than they will be able to with an institutional mortgage.

Remember, the interest on ULMs is tax deductible so they give you the same financial benefits as an institutional mortgage.

The Devil is in the Details
Before you can make a decision about whether to take an underlying mortgage or not you will need to know the details of the ULM. You will want to carefully consider if you can afford to pay off the assessment in cash. If not, you will want to carefully consider whether to take a cash-out institutional refinance or just accept the ULM. You will also want to think about how long you plan on staying in the property and how the assessment will affect your long-term financial position.