Published in the ECHO Journal, October 2009
The question most often heard by association bankers lately is “Are you making loans to HOAs?”
The answer is a resounding “Yes”!
A bank loan can be the best answer to an association with a large project on the horizon, but with reserve balances that are just not sufficient. The interest rates earned on the reserves right now are at a low point. It may be the best time to move forward with your projects. The bank loan will provide the cash needed to get the work done now and allow the homeowners to pay over time.
Electing to defer projects until there is more cash in the bank may not be the best choice. When major repairs are deferred, problems only get worse and more expensive. A recent example is a project that one year ago was in the one million dollar range is now going to be $1.2 million due to additional rot damage. Keeping your buildings in good repair is not only the duty of the board of directors but helps to maintain the property values, which is especially important in this economy. An association with faded or peeling paint and potholes in the streets is not going to be appealing to most buyers. Your homeowners need all the help they can get to begin the process of bringing the property values, and thereby their equity, back to where it was a year or so ago.
Here is How an Association Loan Works:
The loan to the association is considered a commercial loan. No liens are filed against individual units or the association-owned property. The bank’s collateral is the association’s assessment stream. Payment of the assessments, both special and regular, is an ongoing obligation of the unit owners. The association has full rights to lien and foreclose or obtain a court approved judgment when owners do not pay. The bank can step into the association’s collection “shoes” if loan payments are not made in a timely manner.
Most association loans begin as a non-revolving line of credit. As the invoices arrive from the contractors, funds from the loan are deposited into the association’s bank account. The association makes interest-only payments on the balance that is drawn. At the completion of the project, the loan payments begin to include both principal and interest.
Association loans are usually project specific. In other words, if the association tells the bank it is borrowing money to replace the roof and then submits invoices for new trees, a loan draw down transfer will likely not be made. The bank may require copies of invoices and lien releases prior to transferring funds to the association’s bank account.
How To Get Started If the Association is Thinking About a Loan
The terms of the loan will of course vary both from association to association and bank to bank. Some questions to ask when looking for a lender are:
- Is your bank “association friendly”? In other words, does your bank have a focus on the HOA/CID industry and will it understand how the association’s finances work? Has your bank done other loans to associations? Will the bank provide several references?
- How long is the payback?
- Will there be a balloon payment?
- What is the interest rate?
- Are there loan fees? If yes, ask for details.
- Are there any prepayment penalties? If yes, ask for details.
- What if a payment is late?
- If the association moves funds to the lending bank, what investment options are offered?
- What special documentation will be required? Is an appraisal required and what are the costs?
- Will the loan continue to be serviced locally?
How Can You Make Your Association Look Its Best?
Of course, the bank will be looking very carefully at the financial health of the association. They will request what may seem like a long list of documents. By following the guidelines below, you will save time and show that you have a well-run association.
How does the association plan to repay the loan? Have a plan in mind prior to submitting the application.
- Will there be a special assessment? This is generally the best way to fund both your project and the future loan payments.
- Even in this economy, you may be surprised by how many owners are able to pay a special assessment in one lump or perhaps a couple of large payments several months apart. There are owners out there who have existing home equity lines of credit or are noticing that their own funds aren’t earning much. Often they would rather pay the assessment up front, rather than paying over time and having to include the association’s loan interest costs.
- An increase in the regular assessment rate may be sufficient to cover the loan payments.
- Does the association follow its own collection policy aggressively?
- Because the bank’s collateral is the association’s assessment stream, it is important to show the bank that good policies for collection of assessments are in place and that the association follows through on delinquent owners.
- In general, the banks are looking for minimal delinquencies. When an aging report is provided to the bank, be sure it includes detailed information on the status of collection efforts for each delinquent unit.
- If the delinquency report includes owners who are 4 or 5 months delinquent and a lien has not even been recorded, it will not look very good.
- Consider setting up an allowance for bad debts in your operating budget. This will show the bank that the budget is realistic, taking into consideration the level of delinquent owners in the association.
- Write off those units that have been sold through foreclosure. That does not mean that the association needs to stop collection efforts; it just removes them from the active delinquency list.
- While making payments on the loan, it is important for the association to continue funding the components shown in the reserve study.
- Does the association follow the funding recommendations in the reserve study? Bankers often hear something along the lines of “Well, the reserve study is off-base with regard to when that component needs to be replaced.” The answer should instead be “We are working with our reserve study preparer to assure the accuracy of the information and will be allocating sufficient money to fully fund future projects.”
- The minutes and past financial records will be reviewed.
- Has the project been well thought out? Have the appropriate experts been consulted? Will there be a construction manager?
- Be prepared to provide copies of any engineering or other reports.
- Is the cost of the project reasonable considering the value of the property?
- Will the association continue to have a positive cash flow especially once the project has been completed?
- Is the association well managed?
- Have the appropriate steps been taken for approval of the special assessment and, if required by the governing documents, member approval for the loan?
Once all the paperwork has been provided to the bank and the loan has been approved, the board will sign the loan documents and the funds will be available.
By partnering with an experienced association lender your project will be completed in a timely manner and successfully completed. Your owners will have the choice of making payments over time that will better fit their personal budgets while their property values have been protected and in most cases improved.
Geri Kennedy is a vice president at First Bank Association Services. She is the co-chairperson of the South Bay Resource Panel, a member of the ECHO Legislative Committee and a past member of the ECHO board of director. Karl Lofthouse is a senior vice president in the Homeowner Association Banking Services Department at First Bank. He is currently vice president of the ECHO board of directors and is also a member of several ECHO resource panels.