A Five-Point Plan
There are myths everywhere. In the world of co-ops and condos, there is the myth that a condo is a better deal than a co-op because there’s virtually no approval process. There’s another myth that co-op boards are filled with tin dictators, giving potential purchasers the third degree because they get their kicks out of making applicants sweat. And then there’s the myth about co-ops OK’ing applicants if the bank gave them a mortgage because, well, the bank gave them a mortgage.
The first two myths are easily dismissed (co-op approvals = more control of residents = better quality of life; “third degrees” are done to protect the co-op financially), and the third one leads us to the main point at issue: what are the variables a co-op board should consider when it is reviewing a potential shareholder’s application package?
According to professionals, the five most important concerns should be:
1 Debt-to-income ratio and other yardsticks. Generally speaking, co-ops have always been more stringent than banks, says Bob Borger, senior vice president at Prudential Douglas Elliman. Most never assumed that a bank’s approval was sufficient guarantee and they generally asked for more: more cash down, more loan guarantees, more paperwork. “As a result we’ve seen very few co-op bankruptcies over the years,” Borger notes. That conservatism is what helped the majority of the properties weather the financial storms of recent years – storms that revealed that lending institutions were not as careful with other people’s money as generally thought.
If anything, Borger says, co-ops are becoming even “more strict.” Many allow a parent as co-signer but require that the parent offer all the required documents. Some allow a co-signer only if the occupant can meet debt-to-income ratio requirements. Many do not allow non-occupant co-owners, fearing that if the occupant co-owner leaves, the unit will become an investment property. Some are unusually strict: one Manhattan co-op, for instance, requires that if the buyer pays all cash, he or she must put a year’s maintenance in escrow. The reason? The board wants to be covered, since, if the owner falls into arrears or walks away from the unit, there is no third-party mortgage-holder to come in and pay the maintenance.
The most standard yardstick, though, is the debt-to-income ratio, or DTI. This varies depending on the subjective experiences and judgment of the board, although many brokers say that a good rule of thumb is usually a 30 percent (the number ranges from 25 to 33 percent) debt-to-income ratio, meaning that what you spend on housing doesn’t exceed 30 percent of your income. Formulas vary, however: one board recently accepted a buyer with a 43 percent DTI. Brokers say they can often deduce the DTI from past sales at the building but note that there is no specific database for that information.
2 Commitment letter from the bank. Look at the terms and monthly payments of the loan, as described in the commitment letter, and weigh them against the assets and liabilities (see No. 3 below). One change in recent years: a lot of boards will not allow interest-only loans anymore because they don’t accurately reflect the potential buyer’s ability to pay maintenance.
3 Tax returns, credit report. Examine the assets and liabilities. Accountant Jay Menachem says boards should require two years of tax forms so that they can see if the income has been consistent from year to year. Borger advises co-ops to “look at the cash in the bank, the liquid assets. Can the finances be substantiated and verified?” Some boards do not count bonuses as income. Check and see if the potential purchaser has other assets, such as a property or a car, that he or she has to support.
If, for example, the buyer has a home in Los Angeles with a $650,000 mortgage that should figures into his or her liabilities. The buyer not only has a loan for this possible purchase but also has a loan elsewhere. In essence, the person is carrying a million dollars in debt. And extra expenses may mean extra worries: the applicant may be spending too much of his or her income elsewhere and have too little income to keep up with the maintenance.
4 Quality of life. One management executive at a large firm says it is important to remember the nonfinancial aspect of the admissions process. If the applicant is A-OK in every way except for a small problem with the money (you’ll have to determine how you define “small”), you can try to work it out. “Financial difficulties can be adjusted for,” he says, “but if the buyer has a nasty disposition or was a trouble-maker in his last co-op, that’s something that you can’t fix up with money. And this directly affects the quality of life. So I think it’s important to consider it.”
He notes that different credit report companies “offer different levels of information when it comes to that issue. Some companies will do a check of landlord-tenant court to determine if there have been any legal actions against the applicant from a prior landlord or another co-op or condominium. Other credit report companies actually go out and see where they lived and do an inspection of their home, speak to the doorman, superintendent. You get much more in-depth information.”
5 References. Broker Siim Hanja, senior vice president/director at Brown Harris Stevens, notes that references are important. “If it’s just superficial – ‘he’s a great guy, you’d be lucky to have him in your co-op’ – it’s useless. The letters that dig in a little bit and have a little insight to the person do a great job of warming up the person to the board. Reference letters can’t do a great deal of damage to anybody, but they can give a lift up if a genuine effort is made.”
Boards should do their own investigations into references, checking up on contacts who weren’t included in the reference letter package: the co-op or a credit agency (see above, No. 4) should contact a previous landlord or co-op/condo board and ask questions.
At the end of the day, if you’ve asked the right questions in all these areas, you have less chance of being burned.
Habitat, February 2012