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Matthew, a shareholder at a Washington Heights co-op, says he began the process of refinancing his mortgage in August. His new payment will be a third of what he’s paying now, thanks to lower rates.
His board had a policy requiring him to send the directors all the financial forms he had just sent to the bank. No sweat. Done. Then the board’s attorney charged a $275 fee to review the application. Fine. After that, the lender asked the managing agent to fill out a form about the building itself, including a survey of units, occupancy rates, number of sublets, and arrears, as well as a stipulation that there were no liens on the building, a step that Matthew (who requested anonymity) says cost him an additional $250. That was okay, especially since the bank, Chase, indicated that the amount would be refunded at closing.
Matthew knew that other buildings did not require as much as his did – in one case, the board only required the shareholder to submit the paperwork showing the new monthly payment – but he was cool about it. “Anyone with common sense can see that if you can afford to pay X, you can afford to pay Y,” he says. “Who is going to refinance for a higher payment?” Still, he understands the principle of a board asking to see a refinancing shareholder’s financials.
“When a person buys into a co-op, part of the board’s fiduciary responsibility is to make sure they are qualified,” he says. “When you refinance, they usually want at least to know about it, to see if there are any material changes. Are you refinancing because rates are better or because you just lost your job? I can understand the board’s inquiry.”
With interest rates at record lows, many apartment owners and shareholders are looking to refinance their loans. That means copious amounts of paperwork, along with e-mails, phone calls, and faxes. But what does it mean for the board?
Some buildings take the position that if the bank is willing to lend the money, the board is willing to sign off on it without looking at the financials. Considering the shaky state of banking in recent years, that may not be the most prudent course, say some professionals, who suggest that a prudent board should take steps to protect the property’s financial health. In fact, many might argue that it is the fiduciary duty of the board to review refinancing activity. As Matthew correctly noted, facts change: someone with a high-paying job 10 years ago when he bought may be in different financial circumstances now.
Creating a System
Here are the steps prudent boards should follow:
Alert the shareholders. Boards should make sure everyone knows that board approval is needed for refinancing. Provide a list of what is required. If you can demonstrate at the time of your refinance that your new loan is the same or less than your current monthly obligations, some co-ops will forgo the financial scrutiny, says Don Levy, an attorney and vice president at Brown Harris Stevens. “But still there is a fiduciary obligation to be aware of what’s going on in their co-op,” he says. “They need to know how much money is outstanding. It’s more than just mechanics and i-dotting.” (Co-ops, in general, are far more likely to request financials when a shareholder is refinancing than a condo board, Levy says. Part of that is because of the general philosophy that co-ops are more involved than condos in their residents’ financial affairs.)
Review the paperwork – again. According to Levy, most boards ask owners and shareholders to submit the same paperwork they’re sending to the bank for the refinancing: tax returns, pay stubs, financial statements, the appraisal, and the commitment letter from the lender.
Examining the financials is similar to the way the board approaches a new application, although Levy says there is usually a little less scrutiny than with an initial purchase. “The board is looking at the liquidity of the shareholder, and any other current obligations that may not have existed when they first bought that may impact their ability to make the current payment.”
One 60-unit Brooklyn co-op in Park Slope requires that no more than 80 percent of the purchase be financed – a fact that holds true at an initial purchase and refinancing, and a rule that is similar at many co-ops and condos. “We felt it was important for people to have a financial stake in the building,” says Lisa Finstrom, the former treasurer at the co-op. “It’s been my experience that banks would not lend to a co-op buyer in excess of that 80 percent loan to value, which is very helpful.”
That issue can crop up because of increased values – say if a shareholder bought into a building when the apartment was worth $400,000 and now it’s worth $1.2 million. “You don’t want them refinancing 100 percent and going up to that $1.2 million,” she says.
That issue can also come up with decreasing home values, says Pat Lavell, owner of Liberty Home Funding, a city-based mortgage broker. Say an apartment was purchased for $500,000 and the borrower financed 80 percent of that, or $400,000. If the value has dropped to $400,000, the borrower still has to follow the buildings’ bylaws and finance only 80 percent, or $320,000. “That has definitely been a problem for some borrowers,” says Lavell, whose company works with about a dozen lenders and writes about 200 loans a year, mostly for co-ops. “New York City has done well, but it’s not immune to the value problem.”
If a shareholder is trying to draw out equity with a refinancing, that should bring a little extra board scrutiny, says attorney Theresa Racht, a partner at Racht & Taffae.
Racht recalls a recent situation where a shareholder had come into a Sutton Place co-op with an all-cash purchase. Three months later, the person submitted a refinancing application to pull out equity in the apartment. “The board turned him down because they felt that they had been misled,” she says.
But that type of incident is the exception, not the rule. “If someone has a $400,000 mortgage and they’re looking to refinance for $450,000, the board is not going to look at that all that closely,” she says. “If all they are doing is getting a lower rate and are actually lowering their monthly payment, then most buildings kind of rubber stamp those.”
Refinancings are usually done – especially now – to take advantage of lower rates and therefore lower payments. If the board does find something in the financials that gives them pause – say the shareholder is earning less – wouldn’t denying a refinancing put the shareholder in a more precarious financial position, which is even worse for the building’s bottom line?
Levy says that’s true, but boards might still want to say no. Nonetheless, in his experience, Levy says he’s never seen a board reject a shareholder’s request to refinance. “It’s very rare, but it’s still up to the board to review. The board may feel that they don’t have the financial justification to agree to it.”
Boards do not have the right to dictate to the shareholders the terms of their refinancings, such as suggesting that they find a different lender, get a better rate, or get a longer-term loan, and they cannot bar shareholders from taking out cash, Levy says. “They can only say yay or nay.”
Review the recognition agreement. Levy says you should be clear on the details of this document. “The board wants to know what it is agreeing to,” he says. If the board does approve the refinancing, the next step is to sign the recognition agreement and give it to the managing agent, who gives it to the shareholder, so he or she can have it for the closing, he adds.
Mary Fran, the president of the board at a 387-unit co-op in the Inwood section of Manhattan, says as long as shareholders are in good standing with maintenance payments, the board or the management agency, Douglas Elliman, does not get involved in a refinancing. “These days, if the bank approves you, you’re going good already,” she says. “Because they don’t want to give anyone money.”
Be sure your attorney is involved. Finstrom’s board requires its attorney to be involved with a refinancing’s closing process. Shareholders pay about $400, depending on the circumstances. “What we care about as a board is proper documentation,” Finstrom says.
Know who owns the shares. While it has not happened at her building, Finstrom says she has heard of problems when the loan is sold from lender to lender and the proprietary lease or stock certificate does not make its way down the chain. “You can have a situation where you don’t know who owns the shares legally because banks are selling loans so frequently,” she says. “You want to make sure that the share ownership is very clear.”
==HABITAT SIDEBAR 1==
But Is Board Review Right?
Attorney James Samson, a partner at Samson, Fink & Dubow, says it is an “urban myth” that boards have the right to review refinancing financials. “Virtually every proprietary lease has a Paragraph 17 that says a shareholder has the right to pledge shares for a loan period,” says Samson, whose firm represents about 85 buildings. “That means that they have the right to finance. Period,” Samson says. “Most boards and managing agents say they have the right to approve or disapprove. They don’t.”
Samson’s position runs counter to common practices, and manager Don Levy, vice president at Brown Harris Stevens, argues that proprietary leases give boards the latitude to set procedures and reasonable fees for all financial transactions.
==HABITAT SIDEBAR 2==
There are changes afoot for refinancing shareholders and owners. According to co-op and condo attorney James Samson, a partner at Samson, Fink & Dubow, both Bank of America and Wells Fargo now want explanations for any litigation in which a borrower is involved, as either plaintiff or defendant.
Many lenders also want to know about the building’s financial situation. As most co-op buildings’ mortgages are 10-year loans, Samson says lenders want assurances that those mortgages will be refinanced at the end of that time period.
“If the shareholder wants to get the loan, he has to get the board to sign a letter,” Samson says. It’s a safe bet to say that most buildings will be able to get new loans, but Samson says it “puts a board into a box,” with market conditions “that are beyond their control. How can a current board bind a future board?”