Community Collateral Damage: A Question of Priorities

Today's soaring mortgage default rate and the uncertainty and delay associated with mortgage foreclosure proceedings threaten 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-a phenomenon that current law has failed to prevent. But the collateral damage caused by delayed foreclosures and insufficient recoveries can be minimized by increasing the payment priority 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 affects the resolution of the issue because the Federal Housing Administration ("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, delayed foreclosures andunder-collateralized mortgage loans. Decreasing the first mortgage lien's priority during a foreclosure delay would mitigate the harm. Lien priority statutory changes could protect association finances in the future, and such provisions might be applied retroactively as well.

In other contexts, states have held that changes to a lien priority regime could apply to existing associations and existing mortgages without unconstitutionally impairing contract or property rights. This has been particularly true where the association's lien was deemed to have been created on the date the community's organizational documents were recorded (prior to any unit's mortgage). Historically, bank lobbyists have opposed any enhanced assessment lien priority. However, supporting property upkeep and making assessments more predictable and collectible would actually benefit lenders by shoring up the value of their collateral.

Moreover, increased certainty with respect to homeowner payment obligations would enable more responsible credit underwriting and contribute to economic recovery. Shoring up assessment lien priority would not only ensure a fair allocation of community costs, but also would help to contain the current housing market decline.