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 general terms for associa-tion loans? There are infinite questions involving association borrow- ing. When would an association actually need to apply for a bank loan? Management and the association board should be ensuring that there are adequate reserves. If an HOA is applying for a loan, does that mean that it is in dire trouble and that the association is mismanaged? The answer to that question could be yes or no, depending on a few different factors. Associations do not seek loans, however, just because they’re misman-aged or low on reserves. Fortunately, Matthew Driscoll, Vice President of CIT Bank, answered these questions for us.
The best point to start talking about association loans is to determine why an association might need a loan in the first place. According to Driscoll, the reason for taking out a loan, and the different types of loans, are geographically driven. They depend on the type of physical property that comprises the association. The loan may be established for (but not limited to): roof replacements, paving, siding, carpeting for the halls of a building with interior residence entrances, decorating of a clubhouse or lobby, adding a pool, or adding a clubhouse — the list goes on, Driscoll said. An association could obtain a loan for any number of capital repairs or improvements to buildings and common areas.
According to Driscoll, 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 declarations may have imposed requirements that prevented the association from securing and maintaining adequate reserves for its actual needs. Potentially, these documents may impose a minimum amount that needs to be maintained in reserves, Driscoll said. Therefore, those funds cannot be used at the time that the funds are needed.
Who is responsible for paying this loan? Unit-owners are only indirectly responsible for the loan, he said. Are the unit owners personally liable if the association doesn’t pay on time? Can the bank place liens on the individual units for the loan? Unlike a mortgage or home equity loan, Driscoll answered, 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 loan terms commonly assigned to these transactions? Driscoll said that the amount of an association loan can be anywhere from $50,000 to over $50 million, and several factors 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 it generally 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, Driscoll said. The board can raise the monthly or annual assessments to pay the loan.
Either way, terms for an association loan are typically five, seven, ten, or fifteen years. Again, these terms would depend on the project to be financed. According to Driscoll, most association loans are actually paid before their term period expires. For example, he said, a five-year loan is typically paid in three years, and a ten-year loan is often paid in seven. Defaults are extremely rare in association loans. Driscoll noted that association loans are a fairly new phenomenon, only being around for about fifteen years. He also noted 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 commonly determined by the United States Treasury rate. What is required by the bank from the association when applying for a loan? According to Driscoll, banks typically look at a number of items to deter- mine if they can provide the loan to the association. One important factor is the association fee delinquency rate. The bank typically examines this over a period of four months and usually requires there to be fewer than 10% delinquencies in the community. This would include units with ac- counts over sixty 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 maintains this desired low fee delinquency rate. Since these common fees are the only collateral for an association loan, the security of these fees is very important to the lender, Driscoll said.
Another important factor is the size of the association. This affects the association’s ability to obtain a loan. Banks want to ensure that there are enough units within an association to help mitigate potential risk, should owners default. In essence, the more units in an association, the more the repayment of the loan will be spread out over a greater number of owners. According to Driscoll, communities with less than twenty-five units will face some challenges in applying for funding from a bank.
Banks also look at the number of investor-owned units in the community. According to Driscoll, if a community has greater than 40% of its units owned by investors who rent those units, that community could potentially face 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 answered 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, Driscoll said. Additionally, in cases where a loan prevents special assessments or fee in- creases, 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.
Rather than taking out a loan, what if an association decided to replace the roofs in their community over a five-year period, which could be paid from their current assessments? Is there a disadvantage to doing this as opposed to financing the project and doing it all at once? Driscoll said that it is generally more cost-effective to replace all the roofs at the same time, as the cost per unit will be lower when purchasing in bulk. Additionally, there is the added benefit of having everything done at once and having all the units in the community with roofs of the same age. This makes it less likely that additional problems with the roofs will surface during the project if it were to span a five-year period. It also helps plan for future replacements more easily.
Let’s say that an association is applying for a loan to redecorate the hallways of its high-rise building. They have a proposal from the company they plan to use to complete the project, but how does the association determine the amount to borrow? What if there are unexpected costs that come up during the project? Driscoll recommended applying for a loan that is 20% greater than the amount needed for a particular project. He explained that, with the way association loans are structured, there is a draw period, during which the work is usually done. Therefore, the association doesn’t need to draw (that is, borrow) the extra funds if they are not needed. Associations should do this because it is more difficult to go back to the bank after a loan is closed to request additional funds. Doing that would be viewed as a loan modification, which should be avoided by the association. That is why it is very important to have accurate figures and then to leave some room for the unexpected when procuring your loan.