Now and then, a homeowners association will run into financial trouble and require an immediate solution. In addition to special assessments, most boards turn to an HOA loan. But is a loan even advisable?
What Is an HOA Loan?
An HOA loan is simply a sum of cash that a homeowners association borrows from a lending institution (usually a bank) to pay it off with interest. It works similarly to other types of business loans.
Associations generally have two types of loans: an HOA line of credit and a term loan.
An HOA line of credit (LOC) functions in some ways, like a credit card, and associations can use this line to access funds whenever they need it. There is usually a maximum limit to the LOC, and HOAs only have to pay interest on the funds they use. The interest rate can vary monthly, so payments can also go up or down. Most LOCs carry terms of up to five (5) years.
A LOC is perfect for associations looking for quick but short-term solutions. It is a way for HOAs to fund gaps in their budget but not necessarily for large-scale or expensive projects.
On the other hand, a term loan that the association repays regularly over a set period of time with a set interest rate. Unlike a LOC, a term loan releases the entire sum to an HOA simultaneously instead of as needed. And, because the interest rate is fixed, boards can expect to pay the same amount each month, making it easier to prepare annual budgets. While terms can vary, term loans usually carry terms between 1 and 20 years.
Authority to Obtain an HOA Loan
Homeowners associations can generally secure a loan as authorized by their governing documents. These documents should outline the HOA board’s capacity to obtain a loan and any additional requirements related to the action. Sometimes, an HOA’s CC&Rs will require the board to get a majority vote or comply with specific notification procedures.
The authority to secure a loan can be found in state statutes in some states. For instance, Section 7140(i) of the California Corporations Code outlines the power of a corporation to borrow money. In Indiana, there are certain conditions that an HOA must satisfy when securing loans.
Even if state laws and the governing documents are silent on the matter, it is good practice for an HOA board to notify the membership of the board’s plan to obtain a loan. Before securing the loan, the board should open the floor to any comments or questions at the next board meeting.
The Pros and Cons of HOA Loans
As with all other actions, an HOA board must carefully consider whether or not securing a loan is right for the community. Weighing out the pros and cons always helps.
The biggest benefit of a loan is it serves as financing for HOA projects or urgent expenses. It gives the association quick access to funds, which can be very useful in times of emergency. If a common element requires immediate repairs, for instance, a loan can cover the cost without having to levy a large special assessment that homeowners have to pay in a single lump sum. With a loan, owners can pay their share over several months, minimizing the impact on their finances.
In contrast, the most considerable drawback of an HOA loan is the interest rate. Loans don’t come for free, and associations must pay interest on top of the borrowed principal amount. Lenders may also charge ongoing service fees, closing fees, notary service fees, attorney’s fees, and the like.
Additionally, there is a risk of using the loan for the wrong purpose. Boards should never use a loan to lower HOA dues, as it is only a temporary solution. The money used to pay off the loan has to come from the same homeowners, after all. Boards should also never use a loan for their own personal gain.
Do Banks Require Collateral for HOA Loans?
It depends on the lending institution. However, homeowners associations are typically only authorized to borrow from reputable lenders such as banks. And, more often than not, banks don’t require HOAs to produce collateral or other types of security in exchange for the loan.
If a loan goes into default (i.e., the HOA stops paying), banks normally can collect dues and assessments directly from homeowners. Individual board members and homeowners do not become personally liable for the loan. The party that signs the agreement with the bank is the HOA. As such, the bank would have to collect from the association’s funds or source of revenue.
That said, an HOA should only borrow money from a bank if it can repay its debt. Financial planning is of utmost importance when it comes to managing an association. And HOA boards must assess the association’s finances first before entering any agreement with a lender.
Information Needed Before HOA Lending
Generally, the loan process takes about six months from application to closing (excluding the payment terms). The process can involve several steps contingent on various parties, so the timing is not always fixed.
If your HOA wants to apply for a loan, you should expect the bank to ask for the following:
- The amount of money involved;
- How many delinquencies the association has;
- The number of housing units in the community;
- The number of housing units that are owned-occupied;
- Whether or not regular dues will have to be raised to pay for the loan;
- Whether or not special assessments will have to be levied to pay for the loan; and/or,
- The amount of cash as a percentage of annual assessments and debt service (i.e., liquidity);
- The capital planning experience of the association’s management and board members.
Not all banks offer loans to community associations, and some have ill-equipped programs. When browsing for a lender, look at the bank’s offerings. Some banks cater to associations with programs that are designed specifically for them. These are the banks that employ advisors and officers who have experience working with communities.
Seeking Professional Help
An HOA loan can save an association in its time of need. But, no HOA board should ever enter a loan contract without considering everything that comes with it. Financial planning and management are critical at moments like this, and the help of a management company will certainly come in handy.
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