Under what conditions may an association need to apply for a bank loan? Who is responsible for paying the loan? Can board members or homeowners be held responsible in the case of default? What are the benefits, if any, of taking out a loan as opposed to using reserves to fund projects? What are the terms generally for association loans?
There are infinite questions involving association borrowing, but your first one may be “When on earth would an association need to apply for a bank loan?” Management and the board are supposed to be ensuring there are adequate reserves, right? If my HOA is applying for a loan, does that mean we’re in dire trouble and the association is mismanaged? The answer to that question could be yes or no, depending on a few different factors. However, associations do not only seek loans because they’re mismanaged or low on reserves. Fortunately, Thomas Engblom, CMCA, AMS, PCAM, ARM, CPM, PhD, VP/Regional Account Executive at CIT, whose doctorate is in business administration, availed himself to answer these questions for our readers.
The best place to start talking about association loans is to describe what an association may need a loan for. According to Engblom, the reason for and types of loans are geographically driven and depend on what type of physical property the association is comprised of. The loan could be for roof replacements, paving, siding, carpeting for the halls of a building with interior residence entrances, decorating of a clubhouse or lobby, adding a pool, adding a clubhouse — the list goes on. An association could obtain a loan for any number of capital repairs or improvements to buildings and common areas.
Financing litigation against the developer and manufacturers of building materials to remedy construction defects is another reason an association may need to obtain a loan. An HOA loan can be the best way to fund a construction defect litigation suit, as the loan can help the association through the process by funding both legal fees and building costs until the suit is settled — which can take several years.
Additionally, an association’s bylaws or declaration may have imposed requirements that prevented the association from securing and maintaining adequate reserves for their actual needs. Or, these documents may impose a minimum amount that needs to be maintained in reserves. Therefore, those funds cannot be used at the time the funds are needed.
So who is responsible for paying this loan, and are unit owners on the line for the money if the association doesn’t pay on time? Can the bank place liens on the individual units for the loan? Unit-owners are only indirectly responsible for the loan. Unlike a mortgage or home equity loan, the association loan is not secured by any physical elements of the community, including the individual units and common elements. Instead, an association loan is secured by the future assessments to be collected by the association. Additionally, there are no personal guarantors on the association loan, so board members are also not personally responsible for paying the loan.
What are the terms commonly assigned to association loans? Engblom said that the amount of an association loan can be anywhere from $50,000 to $50 million, and several factors will determine the length of the time for which the loan should be cast. This depends on the life expectancy of what is being financed. However, it also depends on the board, and the individual association, and includes factors such as how the association plans to fund those payments. For example, the board can actually special assess the unit-owners in order to repay the loan. In this case, the board can give unit-owners a choice of paying this special assessment as one large amount upfront, or they can pay over a specified period of time with an additional amount to be paid for interest. The board could also raise their monthly or annual assessments to pay the loan.
Either way, terms for an association loan are typically 5, 7, 10 or 15 years. Again, these terms would depend on the project being financed. According to Engblom, most association loans are actually paid before their term period expires. For example, he said, a 5-year loan is typically paid in 3 years, and a 10-year loan is paid in 7. Defaults are very rare in association loans. Engblom noted that association loans are a fairly new phenomenon — having only been around for about 18 years. And, he said that they are among the safest types of loans for banks to issue to customers.
The last component of the loan would be determining the interest rate. This is typically determined by the United States Treasury rate.
So what is required by the bank from the association when applying for a loan? According to Engblom, banks typically look at a number of items which help them determine if they can provide the loan to the association. One important factor is the association fee delinquency rate. The bank will examine this over a period, typically, of 4 months, and usually require there to be fewer than 10% delinquencies in the community. This would include units with accounts over 60 days past due. Additionally, it is common for the loan documents to have language that states that, during the repayment of the loan, the association maintain this desired, low fee delinquency rate. Since these common fees are the only collateral for an association loan, the security of these is very important to the lender.
Another important factor is the size of the association. This will affect its ability to obtain a loan. In referring to association size, typically banks will say “the bigger the better,” when an association is applying for a loan. Look at it this way, the more units in an association, the more the payments will be spread out over a larger number of owners who indirectly affect the repayment of the loan. According to Engblom, communities with less than 25 units will face some challenges in applying for funding from a bank.
The bank also looks at the number of investor-owned units in the community. According to Engblom, if a community has greater than 40% of its units owned by investors who rent those units, that community will have greater challenges with an association loan. Also, if one person owns a large portion of the units or has a large proportion of the voting control of the community, the association will not be approved for a loan.
Lastly, does having a loan on the books of the association affect the owners’ property values or cause the association to be viewed in a negative manner? This question can be viewed in a number of ways and depends on many factors. However, if the loan prevents the property and/or its common elements from deteriorating, such as if the loan prevents putting off necessary projects, which could lead to structural problems or worse, the loan can help maintain or even bolster property values. Additionally, in cases where a loan prevents special assessments or fee increases, residents maintain their personal cash to preserve quality of life, and even have more available funds to put into their own individual units. Having well-maintained and updated units helps bolster property values as well.
Do banks require any documentation from the residents in the approval process of the association loan?
Engblom said no, residents and board members are not asked to provide personal information, such as personal tax returns, when the association is applying for a loan. Nor are the credit ratings of residents viewed. However, residents do indirectly affect the association’s ability to obtain a loan if they develop a history of paying their assessments late or allowing their units to go into foreclosure.