Planned unit development vs condo: the distinction could save your mortgage
The development ownership model affects loan eligibility
- Condo residents do not own any land, only the interior of their units.
- Planned unit development residents own the property on which their unit stands, as well as the surrounding land.
- Lenders have stricter lending requirements for condos compared to planned unit developments.
- Avoid errors in your property appraisal; check the preliminary title report for the legal designation.
If you’re looking at a property in a common interest development — that is, a collection of individual units with shared ownership of certain common areas — you’ve likely heard a variety of descriptors thrown around: townhome, condo, planned unit development or homeowners association.
When buying a unit in a common interest development, the legally designated ownership model is an important factor that affects your loan.
A condo and planned unit development (PUD) are both ownership arrangements defined by law. These arrangements typically include a homeowners association (HOA), which is a fee-based community organization that manages — and sometimes owns part of — the property.
There are many shared design elements between PUDs and condos that can be confusing. To lenders, the appearance of the property is irrelevant. Whether units share walls, are detached, have a garden or are penthouses does not affect whether they are PUDs or condos. A townhome, for example, describes the style of a property. While many townhomes are PUDs and the words are sometimes used interchangeably, the term “townhome” does not hold any legal weight. In fact, a townhome can be a condo or a PUD.
How to finance a condo
As a condo owner, you do not hold title to any land or building structure. You own the interior of the unit, often simply referred to as “air space.” An HOA owns and manages the exterior and common areas. As such, lenders have more stringent requirements when it comes to financing a condo. Not only must the borrower meet individual eligibility qualifications, the lender will closely vet the solvency of the HOA and condo project itself.
To receive financing from federal loan programs, such as the U.S. Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA), the condo must be part of a preapproved list of properties. Fannie Mae and Freddie Mac also have their own lists of preapproved condo projects for lenders that want to issue loans conforming to their standards. Each of these programs require that the HOA and condo project meet strict requirements, such as a limit on the number of rented units as opposed to owner-occupied ones, or restrictions on percentage of space used for commercial activity.
How to finance a PUD
In a planned unit development, the resident owns the property on which the unit stands, as well as the façade and exterior land. Common areas may be jointly owned by residents and managed by an HOA, or owned by the HOA with usage rights granted to residents. PUD residents are required to be dues-paying members of the HOA.
It is much easier to obtain financing for a PUD compared to a condo. Lenders see less risk in PUDs and assess them in a similar manner as they would single-family homes. A PUD does not need to be preapproved to be considered for most loans. Not as much weight is placed on the PUD HOA, and if the property is a detached PUD, lenders may not review the HOA at all.
You can run into trouble obtaining a mortgage if your property is incorrectly evaluated as a PUD or condo. As these terms are often used interchangeably by the layperson, it is not uncommon for tax records or other documents to have mislabeled the property. Lenders and appraisers may take these documents at face value, jeopardizing your financing.
You can confirm your property’s official legal designation in the preliminary title report. This report — and the Covenants, Conditions and Restrictions within it — will state the property’s boundaries and ownership rights, as well as any HOA membership requirements. Obtain a copy from your title company to provide to prospective lenders. Given the many underwriting differences between PUDs and condos, confirming the legal designation of your property is an essential step to obtaining the best loan conditions.