When faced with unexpected expenses or necessary repairs, not all homeowners have funded reserves or the capacity to levy special assessments. Instead, they will take out a loan. HOA loans require adequate planning and understanding the intricacies of association loans can increase your chances of approval as well as help you get the best rates.
Everything You Need to Know About HOA Loans
What Is an HOA loan?
An HOA loan is when you receive a sum of money from a bank, creditor, or financial institution in exchange for future repayment of the total amount loaned — called the principal — plus interest. The interest, which is a percentage of the loan, is the fee charged by the creditor for being able to use their money.
What Is the Purpose of HOA Loans?
One of the most common reasons for taking out a loan is for financing HOA projects or repairs. These could be capital improvement projects that have been long in the making or repairs due to unexpected or emergency situations.
In both cases, the HOA may not have enough funds to pay for the anticipated expenses. HOAs will then take out a loan so that the homeowners won’t have to pay for the entire cost upfront. With a loan, the HOA can spread the total amount over the span of a year or more.
How Do HOA Loans Work?
Compared to personal loans, these loans are issued to the HOA as a non-profit corporation. Thus, creditors do not need to review the finances of individual homeowners. Since associations do not own any property, loans are collateralized through the HOA’s right to assess.
Banks may require HOAs to itemize loan repayments in their annual budget as a sign of loan commitment or levy a special assessment in the amount of the loan plus interest to serve as collateral. In case an HOA is unable to make the loan repayments, the bank may ask for the right to collect from individual homeowners.
What Are the Different Types of HOA Loans?
1. Line of Credit
A line of credit is a flexible type of HOA loan where there is a preset borrowing limit. The HOA can borrow as much as they need until the preset limit is reached. The bank will only charge interest on the actual amount borrowed. Since the interest rate is variable, monthly loan payments are not fixed. A line of credit loan has quick-term periods; it can typically last from a year up to 5 years.
A line of credit is an interest-only loan. The HOA is only required to pay interest while repairs or construction are ongoing. Loan repayments start upon completion of the project or when the credit limit has been reached.
A line of credit loan is ideal for HOAs who have short-term funding gaps. It can bridge the gap until the time when the HOA can come up with sufficient funds. For instance, the HOA may take out a line of credit to repair property damage caused by a natural disaster.
Since repairs are urgent, the association can use the loan to pay for expenses while they are waiting for their insurance payout, which they will then use to repay the loan. A line of credit can also bridge the gap between homeowner assessments and the actual amount needed for repairs.
2. Standard Term HOA Loan
In a standard term loan, HOAs receive the entire loaned amount from their creditor. This is ideal for large-scale repairs or land acquisition. The term period can range from 5 to 15 years. The interest rate is locked so the association pays the same amount each month. Since the loaned amount can be high, HOAs can lower monthly payments by choosing a longer-term period. However, they will end up paying more due to interest charges.
3. Short-Term HOA Loan
This type of HOA loan is the same as a standard term loan, but with a shorter-term period. These loans can last from 3 to 10 years.
HOAs will have higher monthly loan payments but can become debt-free much quicker. You also pay less interest.
4. Line of Credit with Conversion
HOAs can also opt for a line of credit with conversion. This HOA loan has two phases. In the first phase, the loan exists as a line of credit. You will only pay interest on the actual amount borrowed.
At the end of 12 months or upon completion of the project, the loan is converted to a standard term HOA loan. The bank establishes HOA loan rates and the association will then start repaying the principal plus interest until the end of the term period.
What Are the Pros of HOA Loans?
An HOA loan is a long-term financial commitment, but it provides associations with the funds they need to complete necessary or emergency repairs. It is especially helpful for HOAs who have depleted reserves or those who are unable to levy special assessments. Even for HOAs who levy a special assessment, the amount is often not enough to cover all the anticipated expenses.
HOAs can benefit from the fast completion of projects but at the same time, have the payments spread over time. Even if the HOA incurs a debt, they can restore the quality of life of homeowners prior to the damage. Meanwhile, capital improvement projects can increase property values and attract potential homebuyers to the community.
What Are the Cons of HOA Loans?
Perhaps, the main con of HOA loans is the increased financial burden on homeowners. Even though the increase is significantly less than what they would have paid with a special assessment, homeowners will still have higher monthly assessment dues.
If your homeowners become delinquent, the HOA will have a hard time paying back the loan. Incurring debt may also be disadvantageous if your HOA board lacks experience when dealing with loan repayments and capital planning. These scenarios can put your HOA in a precarious financial situation.
Can Condo Associations Take Out Loans?
Both HOAs and COAs can apply for loans. However, it’s important to consult your governing documents to see if HOA loans are allowed. If so, what are the requirements or stipulations? For instance, most HOAs will require approval from the majority of the homeowners before the board can take out a loan.
HOAs should also check their state laws regarding HOA loans. For instance, some states prohibit HOAs to borrow from their reserves or use the reserve fund as collateral for the loan. It’s best to consult an HOA attorney to ensure that everything is okay from a legal standpoint.
How Do I Qualify for an HOA Loan?
HOA loan requirements will depend on the financial institution you are borrowing from. However, in order to assess your HOA’s credit risk, they may ask for the following:
- Delinquency Rate and Total Amount of Delinquencies: If an HOA has a high delinquency rate, the bank may question your ability to make loan payments.
- Total Number of Units and Percentage of Owners vs. Renters
- Reserve Study: Banks may require an HOA reserve study completed in the last 2 years.
- Current Amount in Reserves: Banks prefer HOAs with funded reserves so even if homeowners do not pay their dues, the HOA can still make loan repayments.
- Scope of Repairs and Estimated Cost of Repairs
- Capacity of HOA Board for Loan Management
- Homeowners’ Support for Borrowing
- Monthly Assessment Dues: Banks may be less likely to approve HOAs with already high assessment dues. If loan payments are further added, there is a higher chance of delinquencies.
- Professional Team of Contractors: Banks will also assess the skills and capabilities of the team you are planning to hire for repairs or construction.
Are HOAs Eligible for PPP?
The Payment Protection Program (PPP) is a federal loan to help keep small businesses afloat, particularly in difficult times such as the coronavirus pandemic.
HOAs may apply for a PPP loan as long as funding is still available and the association meets the requirements.
How Do I Plan for an HOA Loan?
HOAs often underestimate the amount of planning required when applying for a loan. Adequate planning is a must if you want to increase your chances of approval. Do not wait until the last minute before consulting your bank. Talk to them early on so that you know which requirements to prepare. Many banks will even work with you throughout the process.
Another way to plan for an HOA loan is to establish the scope of repair and identify your team of professionals. The bank will use this information to determine the size of your loan and your credit risk. Choosing a highly-qualified team of professionals to conduct repairs can increase your chances of loan approval.
HOAs may also choose to levy a special assessment ahead of an HOA loan. The funds raised can be used to resupply your reserve account. This shows the bank that the HOA has several options for repaying the loan. Levying a special assessment can also help you flush out delinquent homeowners.
Are HOA Loans Right for Your Association?
After reading the FAQs about HOA loans, you have a better understanding of what is an HOA loan, how they work, and how to increase your chances of approval. Based on the information, you can also gauge if taking out a loan is reasonable for your HOA. If the HOA foresees any difficulties, it may be worth sticking to other funding options such as increased assessments or a special assessment. Ultimately, the decision will depend on your association’s needs and capabilities.
If you have additional questions about HOA loans and other financial requirements, feel free to contact the Condo Manager team today! Call us at (800)-626-1267, email us at firstname.lastname@example.org, or contact us online to learn more about our HOA software solutions.
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