Community Collateral Damage: A Question of Priorities

Abstract

Today’s soaring mortgage default rate and the uncertainty and delay associated with mortgage foreclosure proceedings threatens to cause financial tragedies of the commons in condominiums and homeowner associations across the country. Assessment defaults in privately governed communities result in an inequitable allocation of upkeep costs, and current law provides no way to prevent this spillover effect. But the collateral damages caused by delayed foreclosures and insufficient recoveries can be minimized by gradually increasing the priority position of the association lien. In a majority of states, association liens are completely subordinate to the first mortgage lien. At foreclosure of the mortgage lien, the junior priority assessment lien will be extinguished whether or not there are sufficient proceeds to reimburse for community charges. Assessment delinquencies grow over time, so the longer it takes to complete foreclosure, the greater the costs to the neighborhood. Although several states have adopted a limited lien priority for up to six months’ worth of unpaid assessments, foreclosures today take far longer than six months, and the amount ultimately owed to a community can be significant and far exceed that cap. Federal housing policy impacts the resolution of the issue because the FHA, Fannie Mae and Freddie Mac only permit qualifying mortgages to be subject to a six-month assessment lien priority. The decelerating pace of foreclosure further exacerbates the already unjustifiable financial impact borne by non-defaulting neighbors. The lien priority status quo fails to adequately protect communities in today’s context of widespread and delayed foreclosures and under-collateralized mortgage loans. Decreasing the first mortgage lien’s priority during a foreclosure delay would mitigate the harm. Lien priority statutory changes can protect association finances in the future, and such provisions may be applied retroactively as well. In other contexts, states have held that changes to a lien priority regime can apply to existing associations and existing mortgages without unconstitutionally impairing contract or property rights. This is particularly true where the association’s lien is deemed to be created as of the date the organizational documents for the community were recorded (prior in time to any unit’s mortgage). Bank lobbyists have historically opposed any enhanced assessment lien priority, but supporting property upkeep and making assessments more predictable and collectible would actually benefit lenders by shoring up the value of their collateral. Better certainty with respect to homeowner payment obligations will also enable more responsible credit underwriting and contribute to economic recovery. Shoring up assessment lien priority not only ensures a fair allocation of community costs, but also helps to contain the current housing market decline.