Bank loans may be a consideration when HOAs look to secure funding for a capital improvement or an emergency repair. While many times loans are viewed in a negative light as taking on debt, loans can grant breathing room to an HOA with budgetary constraints. Sound reason and judgment should be exercised in taking on debt in the name of the HOA, just the same as taking on debt personally.
Loans many times are the most feasible option and sometimes the only option. This is especially true considering annual dues increase limitations that are written into most HOA governing documents. Feasibility is also a factor when constraints in HOA governing documents place limitations on special assessments. For example, depending on how the governing documents are written, an HOA may not be able to special access for anything other than capital improvements. And, vise versa, the governing documents may restrict special assessments to just funding emergency situations. Whatever the case may be, a bank loan may be the only alternative.
Even if the governing documents allow for increasing annual dues sufficiently, or for a special assessment to meet the funding need, there may be unintended consequences. Drastic dues increases and special assessments can ultimately lead to delinquencies increasing and additional collection efforts. The obvious ramifications of increased delinquencies are more funding issues, which hurt the overall property values.
Another issue is that with special assessments and especially with increased dues, the collection period, or the time to collect the funds, may not work with the project at hand. With a special assessment, most HOA governing documents require membership approval.
This approval process, including the notification requirements for the special assessment meeting and resulting membership billing, if passed, could take 3 to 4 months before any funds are even collected. Obviously this would not work for emergency situations and many capital improvement situations.
An additional issue with special assessments is the requirements to pass a special assessment maybe be impossible to meet. This does not necessarily mean the membership voted the assessment down. The assessment passage requirements may be too much to overcome, such as some governing documents requiring a special meeting with 75% of the membership in attendance. In addition to the high quorum requirement, 67% of the members in attendance must vote in favor to pass. Most HOAs would be hard pressed to obtain that quorum level for a meeting in the first place.
While an HOA loan can be closed in under 30 days and, in certain emergency situations, even sooner, there are requirements just as in personal lending that must be met. These lending requirements can vary from bank to bank, so it is important to determine these requirements before the lending process begins. This is why it is generally best to seek out lending institutions that have a track record lending to HOAs.
As in personal lending, the process begins with the completion of the loan application. Along with the most current financial statements (Balance Sheet and Income Statement), banks will need to review two or three years of prior financial statements. The bank will want to review the current year’s budget, along with a current delinquency report. If there are members owning more than one home within the HOA, banks will generally require a list of these members along with the number of homes owned.
Banks view investor-owned homes within an HOA with concern and generally like to see non-owner occupied homes at 20% or less. A single investor owning a large percentage of homes within a community also raises lending concerns. While the percentage can vary from bank to bank, most banks look for no one owner to own more than 10% of the homes within an HOA. Investor owned homes are of concern because of the potential for delinquency issues, especially during economic downturns.
Overall membership delinquencies generally should not exceed 10% of the total membership. Meaning the number of delinquent homes as a percentage of the total number of homes within an HOA should not exceed 10%. Most banks will define a member delinquent if their account is past due for 30 days or more.
The bank will look to see how the loan will be paid back by either an analysis of the current dues structure, a dues increase, or a special assessment. A determination has to be made on how the HOA’s revenue will cover at least 100% of the loan payments prior to the loan closing. In certain situations, considering the overall economy or if there are delinquency issues, the bank may require revenue coverage up to 125% of the loan payments. This additional revenue coverage would allow for payments in economic downturns or with increased delinquency issues.
Loan terms can generally range from 1 to 10 years depending on the nature of the loan need or the improvement. Banks generally will not loan funds for normal operational budget shortfalls. Banks are hesitant and most will not lend to HOAs still under developer control. Smaller HOAs can have issues with obtaining bank loans as well, if the bank deems there are not sufficient members to pay back the loan in the event other members become delinquent.
Because of the intricate requirements of HOA loans, it is imperative to find banks that specialize in HOA lending.
The intricacy or difficulty normally arises because of the collateralization requirements that most banks routinely require with standard loans. No matter what a bank branch lending officer promises, once the loan is submitted to their bank’s underwriting to secure the loan, a personal guarantee maybe required by the board members. A bank that specializes in HOA lending will collateralize the assessments and thus will not normally need any personal guarantees from board members.
Interestingly, banks that specialize in HOA lending look at HOAs in the same way as lending to a municipality. With municipalities having taxing authority and the HOA’s ability to levy assessments, there is always an avenue of collection. While obtaining a loan can appear to be a daunting task, the benefits of obtaining funding quickly and upfront can outweigh the other issues at hand.
William Douglas Management, providing excellent management services to HOAs and condominium associations since 1980.
Copyright 2019 William Douglas Management, Inc.