By Deborah Goonan, Independent American Communities
Is the HOA priority lien necessary and beneficial?
A hot-button issue involving Association Governed Housing – homeowners associations, condominium associations, and cooperative associations – is priority lien status. Currently 22 states, the District of Columbia and Puerto Rico have assessment priority lien statutes. (See the list of states at the end of this article.)
The case for priority liens – the industry perspective
Community Associations Institute (CAI) makes its case for priority lien status of “community associations” in its official Public Policy: (emphasis added)
In order to recover their losses, lenders and associations attach liens to the property and compete in a foreclosure sale for the debts owed. Generally, liens are prioritized by the common law principle, “first in time, first in right.” Under this principle, the mortgage lender who properly records a mortgage always has priority over any association claim. When foreclosure proceedings are instituted, mortgagees are typically always winning bidders of the sale. In turn, this leads to the extinguishment of the association lien and leaves the association without any recourse to recover delinquent assessments. “First in time, first in right” places all of the burdens on the association during a foreclosure. Priority lien statutes embody a careful balance of the interests of homeowners and lenders in community associations.
For more than 100 years, priority liens have been used for mechanic and tax liens. Today, approximately 22 states plus the District of Columbia and Puerto Rico have adopted a variation of priority lien language to allow community associations to collect delinquent assessments. State statutes are modeled after uniform codes which provide an association a lien priority over the first mortgage or deed of trust for a modest six (6) months of delinquent assessments. Meaning, when a home is foreclosed upon, the community association would be first in line to be paid out of the proceeds of the foreclosure sale before any other creditor.
A legal, academic perspective
In 2012, Cardozo Law Review published a paper entitled LIEN PRIORITIES: THE DEFECTS OF LIMITING THE ―SUPER PRIORITY FOR COMMON INTEREST COMMUNITIES by Daniel Goldmintz. The author makes a case for federal housing policy that would place assessment liens for Association Governed Housing entities into first lien status – prior to local property taxes and mortgage lenders.
A statutory scheme of lien priority in an association foreclosure is essentially one of burden allocation. While “first in time, first in right” placed all of the risk and burdens onto the association during a foreclosure proceeding, the six-month super-priority was designed to spread and share the burden with lenders.110 As discussed, however, the super- priority scheme is hardly balanced: In practice, associations now collect a fraction of the total maintenance dues and have to wait, unpaid, until lenders finally decide to foreclose.
Moreover, association burdens are further exacerbated since they are inexplicably given a junior lien relative to a government lien, irrespective of whether the government lien was first in time.115 Indeed, this follows the trend of state statutes generally, which place junior government liens before all other liens.116 However, there seems to be little rationale for doing so.117 This makes even less sense when considering the fact that associations typically take on the role of a mini-government, providing services and public goods that are otherwise the responsibility of local government.118 These services include parks, street paving, lighting, snow removal, water and sewage facilities, recreational facilities, and garbage collection.119 This ―load-shedding‖ of public services onto associations relieves the often tightly-squeezed municipal budgets of the responsibility of expanding the municipal infrastructure alongside the growth of the municipality‘s population.120 Thus, while associations pay out for government-like public goods during prosperous times, they collect as junior lienholders relative to government entities during the foreclosure process.
Put simply, Golmintz’ legal argument is that an Association ought to be able to collect on the full amount of its lien, and not be limited to merely 6 months of assessments, as is the case for most states with super lien priority statutes.
The argument is a convincing one, if highly unpopular with mortgage lending industry.
Golmintz highlights the similarities of Association Governed Housing developments to municipalities, in terms of the types of services they provide.
Quite clearly, lenders and policy makers do not equate private, collective housing arrangements, most of them incorporated, as mini- or quasi-governments – at least not to the extent that they are willing to put Associations in line ahead of the local governments that continue to promote or mandate that all new residential development must create mandatory associations for the purposes of maintaining themselves.
As long as the priority lien is limited, however, lenders have very little incentive to speed up the process of foreclosure, and tend to neglect paying assessments on properties in limbo for several years.
CAI argues that priority lien state law provides a “priority in right”
But CAI is not satisfied with merely collecting its delinquent assessment lien when the bank forecloses. Instead, the trade group is fighting for the right of Association Governed Community foreclosures to extinguish (eliminate) the first mortgage. CAI concludes in its Public Policy that:
States should adopt, or opt to strengthen, priority lien statutes to enable community associations to perform their role in maintaining critical services. CAI encourages at a minimum for states to adopt the 2014 revised version of UCIOA Section 3-116 priority lien language. Statutes that do not reflect the UCIOA language may be strengthened by increasing the period of time for which associations are given a lien, explicitly stating priority lien is a priority in right and not merely a priority to payment, and including in the priority lien, reasonable attorney’s fees and costs associated with collection.
The priority lien controversy is summed up well in this 2014 article
DAILY REAL ESTATE NEWS | THURSDAY, OCTOBER 16, 2014
A recent court decision in Nevada has put mortgage lenders and housing associations at odds over the sale of foreclosures in a case that could have implications nationwide, The Wall Street Journal reports.
The tension stems from homeowner associations who put liens on properties when home owners stop paying their HOA dues. Homeowner associations, similar to lenders, can foreclose on homes to recoup delinquent payments. Nevada, as well as 20 other states, has laws giving HOA liens priority over first mortgages. That allows HOAs to put a home up for auction and sell it without the mortgage lender’s approval, eliminating the first mortgage and then allowing an investor to secure the title of the home. Because HOAs are mostly motivated to recoup the delinquent association fees, the homes they put up for auction — many of which are worth hundreds of thousands of dollars — are being sold for just a fraction of the cost.
FHFA opposes priority liens that wipe out a first mortgage
In light of the Nevada court decision, as well as a similar ruling in District of Columbia, Federal Housing Finance Agency (FHFA) has issued two formal statements that first mortgages under its conservatorship of Fannie Mae and Freddie Mac must not be extinguished without consent.
FHFA’s reasoning is simple: its administrative oversight of Fannie and Freddie is funded by taxpayer dollars, therefore, the agency cannot afford to unnecessarily forfeit first mortgage debt payments following a foreclosure sale.
That would be like asking Americans who have never lived in an HOA to make it possible for a buyer at the association’s foreclosure – often a real estate investor – to practically steal a home for nothing.
National concern for mortgage lenders
Mortgage lenders are concerned about the extent of priority lien rights of Association Governed Housing entities, because, according to reports by Equifax,
More than 200,000 HOA-linked homes are in delinquency. And 42% of all delinquent home loans are in super lien states, according to data and technology company Sperlonga in February 2015.
Data from Sperlonga shows the portfolio risk nationwide, and the scope of the uphill battle is evident: out of 1 million homes in HOAs, 200,000 of those are in delinquency, and the average amount of delinquency is $7,200.
This might seem like a relatively minor issue, but there are instances where money due to an HOA actually takes priority over that of the principal mortgage — effectively halting a short sale, foreclosure or preventing the property from entering REO status. Currently, 21 states have what is known as “super-lien” status, giving past-due amounts priority over any existing mortgage, and according to Sperlonga, 42% of all delinquent loans are located in these states.
Additionally, 34 states allow nonjudicial foreclosures, which means the association has the right to foreclose without a formal court proceeding.
You would think that the solution is easy: lenders should just pay assessments owed in order to protect their first lien.
However, verifying which residential properties are located in some sort of common interest community with Association-governance is not as straight forward as you might assume.
According to Equifax, on identifying HOA assessment delinquencies, private industry has taken the lead in creating a national database of HOAs.
Equifax now offers HOA Identification and Delinquency Check powered by Sperlonga Data and Analytics. Access to Sperlonga’s HOA database that contains information on nearly 225,000 of the estimated 350,000 HOAs in the U.S. will help you identify properties associated with an HOA, while facilitating compliance with GSE requirements and other government guidelines.
Readers of IAC will recall that the U.S. Census does not specifically track population or residential dwellings located in Association Governed Housing developments, commonly referred to as HOAs.
Note that Sperlonga’s database is missing a minimum of 125,000 HOAs, based upon CAI’s estimated total of 350,000 HOAs.
Let’s look at the Big Picture for Consumers
From a consumer perspective, if FHFA is forced to lose BIG money on extinguished first mortgage liens in super priority lien states:
- GSEs (Government Sponsored Enterprises) like Fannie Mae and Freddie Mac will be less likely to insure or repurchase such mortgages.
- That will result in reluctance of banks to underwrite mortgages in those priority lien states, especially for more affordable homes.
- Lenders will have less available liquidity – less money – to lend to other taxpayers in the U.S. at affordable interest rates and favorable repayment terms.
Essentially, wiping out the first mortgage lien ultimately forces other borrowers to pay more for a mortgage, makes it more difficult to obtain a mortgage, and makes homeownership more elusive.
But CAI does not see it that way, and they have been exerting their influence with the U.S. Congress at the federal level.
How did we get here?
Let’s not forget that no one from CAI complained during the real estate frenzy when properties were selling faster than developers could build them.
Who initiated shaky loans? In many cases, it was the developer or a broker-affiliate! Not only were developers and investors making money on the sale itself – they were taking a cut on loan origination.
There were resales, too, but many of those were also in a planned community where construction was ongoing in newer phases.
It’s also true that banks were making a fortune on bad loans, only to sell them on the secondary market. In general, banks didn’t care. Yes, banks are now dragging their feet on following through with foreclosure, not paying assessments all that time.
It’s one thing to for an Association place a lien to collect its payment upon bank foreclosure. It’s quite another for the Association to rush to foreclosure before the bank, in order to wipe out the first mortgage.
Incidentally, if banks had been regularly escrowing 6 to 12 months of assessments – at least for essential services – then they would have been distributing those funds back to associations, just as they now forward tax payments to local and municipal government entities.
But where do we go from here?
If CAI is so adamant that banks were responsible for saddling associations unit owners who cannot pay, then why has the trade group been setting up the next bubble by fighting tooth and nail for FHA standards to be relaxed? Why is CAI lobbying for lower down payments, lower PMI insurance, and lower owner-occupancy and higher commercial occupancy thresholds in condo associations?
Clearly, reducing the risk of future assessment delinquencies is not compatible with those goals.
Perhaps that is why CAI sees the priority lien as essential.
CAI is aligning itself with the Massachusetts Congressional Delegation
(CAI) recently announced an apparent Congressional alliance in their fight against FHFA’s policy of disallowing HOA priority liens to extinguish a first mortgage if the association forecloses before the bank holding the mortgage. According to the news release by CAI:
Led by Senator Elizabeth Warren (MA-D), the Massachusetts congressional delegation wrote to urge Federal Housing Finance Agency (FHFA) Director Melvin Watt to reconsider FHFA’s attack on state-level priority lien laws.
The letter written by Senator Elizabeth Warren (D-MA), and signed by a Senator and nine Congressional Representatives, reads, in pertinent part, as follows:
Request for Delay and Solicitation of Public Comments As FHFA’s actions and statements reflect, it has discretion to determine whether to consent to foreclosures brought under state super lien laws. The agency’s decision to rely on HERA to categorically withhold consent for such foreclosures – and to aggressively challenge any foreclosures initiated under state super lien laws – represents a significant shift in policy several years after the enactment of HERA. FHFA did not solicit public comment on that policy change even though its new position could potentially affect millions of homeowners and thousands of loan servicers and community associations. Given the widespread effect that FHFA’s new policy will have, believe the agency should solicit and consider public comments before implementing it. Accordingly, we request that FHFA delay implementation of its new policy on state super lien laws and set up a process for obtaining and reviewing public comments on the issue. FHFA should consider how its policy would advance each of its statutory purposes, including its obligation to ensure that “the operations and activities of each regulated entity foster liquid, efficient, competitive, and resilient national housing finance markets.”
CAI is sure to generate a great deal of “public comment.” Housing consumer advocates need to generate even more of their own on this issue. In that spirit, here are some points to consider.
Is the priority lien really necessary and beneficial for consumers and taxpayers?
Essential vs. Discretionary services
CAI makes a big deal out of the fact that Associations must pay to provide what they call critical services.
Community associations all require homeowners to pay assessments to the association to carry out critical services. These critical services include maintenance of common elements, maintenance of community infrastructure (roads, bridges, and storm water systems), obtaining insurance coverage, and providing for utility services. Community association boards also ensure that funds are set aside in capital replacement reserves so owners are protected from large, unanticipated special assessments. To ensure these community functions are met, all homeowners pay regular assessments, which are lien-based. An association’s financial obligations rely on consistent payment of assessments to operate and do not change when assessments are not paid.
This is an oversimplification of the purpose of assessments and the annual budget. How is the Association deciding what to charge for assessments? Methods used by homeowner volunteers to calculate proper assessment levels are often questionable, to say the least. They tend to be grossly understated or overstated.
And not all assessment dollars are necessarily for essential services. As previously covered in a blog explaining the IRS tax deduction proposal that CAI supports, part of assessments do, in fact, cover discretionary expenses.
Discretionary services can be cut OR assessments can be raised to cover costs over and above essential services.
Why is nobody at CAI talking about this concept of essential vs. discretionary services? After all, it’s standard fodder for discussion in all stable governments and businesses, isn’t it?
Should the discretionary portion of an Association’s assessment obligation be subject to priority lien over a first mortgage?
Does the priority lien result in a faster recover from economic crisis?
Also according to CAI: (emphasis added)
Massachusetts passed their priority lien law in 1992. Today, Massachusetts banks recognize the priority lien law as a win-win-win for all involved. The banks, home owners and community associations have found the priority lien law to be a critical tool for economic recovery in their community. The net result of more than two decades of priority lien law includes – a much faster recovery from the 2008 housing crisis, rising property values, higher common area service levels, lower legal fees and faster transition of abandoned homes, which creates blight and distress within communities.
Let’s take a look at some facts.
Falling foreclosure rates are directly tied to a housing recovery. So, if CAI’s statement is correct, one would expect states with priority lien statutes in place to have lower foreclosure rates, and fewer days for banks to complete those foreclosures.
Both factors would indicate a “faster recovery” than states without priority lien status for homeowners, condominium, and cooperative associations.
After all, if the purpose of the priority lien is to force banks to pay their fair share of assessments or risk losing their financial interest in the first mortgage, then banks in priority lien states should be moving more quickly to foreclose.
But we know that’s not happening. Not by a longshot.
In fact, in April 2016, of the top ten states with the highest foreclosure rates, eight are priority lien states. I created Table 1 below to illustrate the fact that priority lien statutes have no apparent beneficial effect on the reduction of mortgage foreclosure rates. The states in blue are priority lien states.
Ironically, five of the eight priority lien states exhibit higher foreclosure rate rankings than they did in May 2015.
(Table 1 – Foreclosure rates and HOA Priority Lien states (Independent American Communities)
Foreclosure rates source, RealtyTrac: http://www.realtytrac.com/StatsAndTrends/EmbedRTChart/ForeclosureRates_national:US
Additionally, according to RealtyTrac, the average number of days to foreclose has risen steadily since 2007, and continues to do so, despite the fact that 22 states have relied upon the priority lien as a tool to collect past due assessments for Association Governed housing.
Realty Trac chart of Days to Foreclosure (Source: http://www.realtytrac.com/news/foreclosure-trends/midyear-2015-foreclosure-market-report/)
CAI’s argument in favor of expanding priority lien rights to include extinguishing a first mortgage cannot be supported by the facts. Priority lien status does not speed up the bank foreclosure process, reduce foreclosure rates, or contribute to a faster recovery of Association Governed Housing entities.
On the contrary, it can be argued that allowing HOAs to wipe out mortgage liens will only create an economic environment where it becomes more difficult to sell existing homes, decreases affordability for home buyers, and discourages homeownership.
Currently 22 states, the District of Columbia and Puerto Rico have assessment priority lien statutes.
Alabama: 6 months Judicial and Non-Judicial
Alaska: 6 months Judicial and Non-Judicial
Colorado: 6 months Judicial and Non-Judicial
Connecticut: 9 months Judicial Delaware: 6 months Judicial
DC: 6 months Non-Judicial
Florida: 12 months Judicial
Hawaii: 6 months Judicial and Non-Judicial
Illinois: 6 months Judicial
Maryland: 4 months; $1200 Judicial
Massachusetts: 6 months Judicial
Minnesota: 6 months Judicial and Non-Judicial
Missouri: 6 months Judicial and Non-Judicial
Nevada: 9 months Judicial and Non-Judicial
New Hampshire: 6 months Non-Judicial
New Jersey: 6 months Judicial
Oregon: Unlimited Judicial and Non-Judicial
Pennsylvania: 6 months Judicial
Puerto Rico: 6 months Judicial
Rhode Island: 6 months; $7500 Judicial and Non-Judicial
Tennessee: 6 months Non-Judicial
Vermont: 6 months Judicial
Washington: 6 months Judicial and Non-Judicial
West Virginia: 6 months Non-Judicial