[NOTE: This article first appeared in the Spring 2012 Edition of Hyatt & Stubblefield, P.C.'s "Community Developments"]
Last summer we reported that the Federal Housing Finance Agency (FHFA) had moved beyond proposed "guidance" and had proposed a final rule in its effort to restrict Fannie Mae and Freddie Mac and all federal home loan banks from purchasing mortgages on properties in communities with "private transfer fee covenants."
The proposed guidance broadly construed the term "private transfer fee covenant" to include essentially any kind of transfer fee payable on successive transfers of property regardless of who collects the fee or the intended use of the fee. This would have adversely impacted many communities with covenants that provide for collection of such fees as contributions to working capital or capital reserves, for community enhancement, or to fund nonprofit entities organized to promote cultural, educational, environmental conservation, historic preservation, and similar purposes.
FHFA's proposed final rule purported to exempt transfer fees paid to homeowner associations to be used for the direct benefit of the community. However, the language of the proposed final rule created numerous practical and interpretative issues reflecting a lack of understanding as to how such fees are really used. Due to the difficulty of determining when a transfer fee qualified for the exemption, the proposed final rule would have created major problems for financing of home purchases in communities with transfer fees.
During the public comment period, we submitted comments suggesting changes and revisions to the proposed final rule to minimize its impact on communities with transfer fee covenants designed to benefit the community. On March 16, 2012, FHFA published its final rule which becomes effective July 16, 2012. It adopted many of our suggestions. You can find a copy of the final rule at www.gpo.gov/fdsys/pkg/FR-2012-03-16/pdf/2012-6414.pdf.
The final rule prohibits the "regulated entities" (Fannie Mae, Freddie Mac and all federal home loan banks) from purchasing, investing or otherwise dealing in mortgages secured by properties encumbered by a "private transfer fee covenant" - unless it is an "excepted" transfer fee covenant. Excepted transfer fee covenants include those which require the payment of the transfer fee to a "covered association" if the use of the transfer fee is limited exclusively to purposes which provide a "direct benefit" to the encumbered property. The term "covered association" includes condominium associations, homeowner associations, cooperatives, and any organization described in Section 501(c)(3) or (4) of the Internal Revenue Code. It does not include for profit entities such as a mandatory membership club owned and operated by a for profit entity.
To qualify as providing a "direct benefit," the transfer fee must be used exclusively to support maintenance and improvements to the encumbered property, or for acquisition, improvement, administration, and maintenance of property owned by a covered association of which the owner of the property is a member and used primarily for the benefit of such members. A direct benefit also includes cultural, educational, charitable, recreational, environmental, conservation, or other activities which are conducted in or protect the community or property which is adjacent or contiguous to the community or are conducted on other property that is used primarily by the residents of the community.
The direct benefit requirement disqualifies transfer fees used to benefit property which is not located adjacent to the community or used primarily for the benefit of the property owners who pay them. FHFA stated in its findings that transfer fees to fund preservation or environmental projects may be meritorious from the perspective of society as a whole; however, they do not contribute directly to the value of the property and contribute to the valuation concerns the rule is intended to address.
The rule in its final form does not prohibit private transfer fee covenants. Rather, the final rule simply prohibits the regulated entities from purchasing mortgages on properties burdened by a private transfer fee covenant. The prohibition only applies to private transfer fee covenants encumbering property after February 8, 2011. Mortgages on property encumbered by a private transfer fee covenant recorded before that date are "grandfathered in" and eligible to be purchased by such entities to the extent that they were valid prior to the effective date of the final rule.
The final rule does not affect covenants which impose the payment of "one time" fees. For example, a private transfer fee covenant which requires the payment of a transfer fee on only the first transfer, even if it is for a purpose which does not provide a direct benefit or to an entity that is not a covered association, would not be disqualified for purchase by the regulated entities.
A community which is subject to a transfer fee covenant may need to amend its covenants to clearly state and limit the purposes for which the transfer fees can be used. The use of the transfer fee must be specifically limited to those permitted by the final rule in order to limit or avoid having lenders reject mortgage applications or title companies refuse to issue title policies.
In addition, 38 states have enacted laws regulating or prohibiting private transfer fee covenants. Many of the states' laws exempt transfer fees when paid to a community association. However, some states have banned them completely. Even in those states where a transfer fee covenant is permitted or prohibited but "grandfathered in," the community may need to take affirmative steps to perfect the transfer fee covenant either by recording or filing specific notice in the land records.
If you have any questions on the applicability of this new rule, how it will impact your community, or the status of transfer fee covenant legislation in your state, please contact us.