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HOA and Condo Association loans are cash-flow based

HOA Loan Security

As stated earlier, the community association usually does not own any real property on which a second mortgage position can be taken to collateralize a capital improvement loan. While some loan officers have chosen to ignore the community association as a borrower because of the absence of such collateral, a loan officer who thoroughly understands the structure of the community association should nevertheless be able to obtain adequate security for the loan. Financing capital improvements that involve large investments in equipment, such as the replacement of a heating and air conditioning system, provides the lender with security if the lender takes a security position in the equipment and files a Uniform Commercial Code (UCC) secured transaction financing statement.

For HOA loans not involving equipment, the lender can take a security interest in the assessments to be paid by the owners of units. This security interest may also be perfected by filing a financing statement in accordance with Article 9 of the UCC. While lenders might seek a pledge or security interest in all assessments to be received by the association for the term of the loan, lenders should be aware that certain expenditures such as insurance will be required of the association by state law.

Therefore, it would not be fair or perhaps even possible for an association board of directors to pledge all the assessment income. The HOA lender, however, can easily require that an association's budget have a line item equal to the debt service on the loan and have it pledged. As has also been mentioned, many lenders have required associations to conduct all their banking with the lender during the term of the loan, and the lender obtains a perfected security interest in such condo association's bank accounts.


Cash flow requirements for HOA loans

Our last two HOA Board of Directors have been looking for some time at an HOA Loan as an option for a $1M required renovation. I'm trying to get an idea if there is a standard monthly income (assessment) to debt payment ratio (similar to the 28% used for personal mortgages) to give some guidance. Our property management company came up with an initial offer but the ratio was 44% and seemed excessively high to be sustainable for 10 years to us. Can you give me an idea on the usual ratio so we can start looking again?

I can tell from your question that your former Condo Association Boards have been approaching banks that have no understanding on how to lend money to a community association. Believe it or not, there are banks that are specialized in providing such HOA loans. You might also want to know that the community association industry has proved to be the safest market for a bank to lend to.

The approach that you reference of a ratio of assessment income to debt payment ratio is not the right approach. Community association loans are looked at on a cash flow basis. The view is what the the impact to the annual budget will be. In essence, how much larger a check will a unit owner will need to write each month.

Let me give you a very rudimentary example. An association has 100 units that are paying $250 per month. They have a break even budget. So, the annual and monthly income is: 300,000 / $25,000.

A $1.0 million HOA loan at 6.25% for 10 years causes a monthly loan payment of $11,228. That means that the monthly amount amount due from each unit owner is $112.28. So, their new annual/budget is: $434,736 /$36,228.

This is a very simple representation. Each community has different needs and structures. The loans are very much tailored to the association.


HOA Loans for Financing Projects

Residents of a condo association building faced a quandary. Ignored, old and failing pipes in the building could burst at any moment and cause severe water damage. The fix, however, came with a hefty $1 million price the condo association didn't have.

And because the condo association had no real collateral, its condo board members wondered who would loan them the funds to make the overdo repairs.

Contractors are now repairing the plumbing. In the meantime, the HOA loan is allowing the individual condo owners to pay for the repairs over a 10-year span instead of having to come up with a large HOA assessment.

The HOA loan or condo association loan allowed the group to do all the repairs at once, rather than do it themselves or spread the work out over time. HOA loans or condo association loans are finding that this market niche can provide a significant source of business, although it does come with a unique set of challenges, HOA loan providers warn.

A Growing Market HOA Loan Market

It's little surprise that banks would be interested in working in this homeowners association market given its numbers. In 2006, 286,000 community associations governed more than 23 million housing units across the United States, with roughly 57 million residents, according to the Community Associations Institute.

These condo associations and HOAs spend significant money, too. The Community Associations Institute estimates that the annual operating revenue for allcommunity associations in the United States is more than $41 billion, which condo associations spend for goodsand services-including repairs and maintenance-to keep their condominium buildings, townhouse communities and subdivisions running.

Condo Association Loan Challenges Homeowners associations, HOAs and condo associations are supposed to condo reserve money tomaintain and upgrade the common areas of their condo associations and HOAS. In condominium buildings, this can mean upgrading hallways and replacing condo building roofs. In townhouse communities or housing subdivisions itmay mean sidewalks and parks. The problem is mosthomeowners associations and condo associations donot do this properly. Its estimated that 90 percentof all condo associations do not condo reserve enough money to handle repairs. That's why the condo associations need Condo Association Loans or HOA Loans to replace that leaky roof or crumbling driveway.

The one piece of collateral a condo association or HOA has is the legal right to levy condo unit owners in the formof condo association assessments or monthlycondo fees. Holding this right this condo assessment right as collateral, HOA loan providers or condo association loan providers could put a receiver in place to collect monthly condo assessments or condo fees to pay back the HOA loans if the condo association were to default. Because of this, the HOA loan interest rates may be a bit higher.

Condo Association Loan providers must also be preparedto contend with a revolving voluntary condo boards. But might just create an opportunity to put some of HOA loan providers and condo association loan providers small businesses lending skills to work.


Assessments are HOA Loan Collateral

HOA Lenders' Reactions

Unfortunately, experience has shown that many HOA lenders turn a deaf ear to the borrowing requests of condominium or homeowners associations once they learn there is no second mortgage position with which to collateralize the HOA loan. As is the case with a condominium association, a homeowners association owns no property, yet it would be the entity seeking the HOA loan. By comparison, the homeowners association does own and does hold title to the common areas of the development. In a practical sense, however, these common areas would not be of value as HOA loan security to a lender because the land and recreational facilities are so burdened by easements and use restrictions that they would have little marketable value upon which a lender could collateralize a capital improvement loan.

To service this growing market, HOA lenders must look beyond the traditional approach of requiring a second mortgage position for such loans. HOA lenders must view the community associations as commercial borrowers that have a guaranteed cash flow based on the assessment and collection powers of the condo association. The assessment and collection powers of the community association will be a key in a loan officer's decision.

Assessment and Collection Powers

Powers of collection and assessment will vary from state to state. In the case of the condominium association, a state's condominium act will be the primary source of collection powers. The condominium documents will supplement and delineate the powers for a specific condominium within limits of state law. Courts have repeatedly upheld the powers of condominium and homeowners associations to collect assessments through court action.

The typical homeowner association's collection power is not based on state law but on recorded restrictive covenants. The lien is not statutory and must be recorded. Furthermore, homeowners associations are more limited in terms of recovery of attorney's fees, in some cases to the extent that it becomes economically unprofitable for the homeowners association to pursue a delinquent condo owner.


What Are Condo Association Loan Documents?

Condo Association Loan and HOA Loan Documentation

HOA Loan documentation will include a loan agreement, a promissory note, a security agreement and financing statement, and a collateral assignment or conditional assignment of assessments. In addition to the terms of the loan, the agreement should carefully state and describe the security for the loan in terms of all condominium association assessments or the line item in the budget for the loan service. The security as stated above can also include the security interest in bank accounts placed at the lending institution.

The loan agreement also should include a statement that debt service shall be included as a separate line item in each annual budget of the association beginning with the first annual budget after the loan is made and all budgets thereafter during the term of the loan. The borrower should agree that the amount of the annual budget and the amount of the annual assessments and carrying charges levied against the condominium owners shall at all times be in an amount sufficient to service the loan and to meet all annual expenses of maintaining and operating the condominium or home-owners association.

The lender also may wish to include in the agreement a requirement that the association furnish on a regular basis a list of the owners who are delinquent in paying their assessments. In this way, the lender may discover potential problems in collection and forestall such problems. Finally, the lender should require a submission of the borrower's annual budget during the term of the loan.

The security agreement and financing statement should be drawn to satisfy the requirements of Article 9 of the UCC. The statement will include a security interest in all bank accounts of the debtor (borrower) and all of the debtor's rights, title, and interest in all present and future condominium assessments payable to the debtor from all unit owners. A conditional assignment of the assessment can be drafted so that it becomes operative on any default made by the association. It will remain in full force and effect as long as any default of payment of the loan continues. Through this instrument, the borrower will have conditionally assigned, transferred, and set over unto the lender all its rights, title, and interest in present and future assessments that are due to the borrowing association from each unit owner.

In reaching decisions about lending to the community association, loan officers should pay special attention to the assessment collection records provided by the association. Study of such records will show how the association has been able to manage its cash flow and thus will give a true indication of its ability to service the debt through a line item in the budget. Since the condo association budget would include a line item for debt service, the loan officer must determine from the association's documents how the budget is formulated and whether unit owners have the power to vote down a budget proposed by the board of directors.


How a Condo Association Loan Provider Judges Creditworthiness

Judging Creditworthiness of an HOA or Condo Association

The documents required in a HOA capital improvement loan request by a community association will be substantially the same documents that a lender requires from any commercial enterprise. Loan officers should receive:

  1. A description of the capital improvement involved or the repair work envisioned.
  2. Engineering reports or analysis regarding such work, if applicable.
  3. Bids or estimates for the work to be done.
  4. Financial statements of the association for at least two years. (A sample income statement for a resort-area condominium is shown in Figure 4.)

Necessary documentation particular to the community association borrower includes an asset collection analysis to show what percentage of the association's monthly assessment is collected in a timely manner. The condo association should also provide a statement of its collection policy. The loan officer should request that the association provide a ratio of outstanding/ late assessments to budgeted assessments receivable. A percentage to show the amount of timely collected assessments will also be indicative of evenness in the association's cash flow. The lender should inquire whether the association has a standard policy for treating delinquent unit owners.

The condo association must provide the lender with copies of the association's documents that outline assessment and collection powers. Also, the association should provide documentation to verify its statutory or corporate power to enter into the loan transaction. The condo board of directors for the association should provide a corporate resolution of its approval of the loan in which the purpose of the loan is set out. Finally, HOA loan officers should require an opinion of the association's legal counsel to include a confirmation of the power to borrow and a brief analysis of the statutory and documentary bases for assessment and collection power.


HOA Loan or Condo Association Loan uses

HOA loans and Condo Association Loans to community associations, condo associations and HOAs are becoming more popular. HOA Loans, also knowns as Condo Association loans are a great alternative to special assessments to condo association owners, because the condo association get the HOA Loan or Condo Association Loan proceeds up front and the HOA loan can be paid off over time, enabling the HOA or condo association to build in the cost of HOA loan into future condo fees or sporadic, smaller condo assessments.

Some uses for HOA loans include, but are not limited to:

  • Purchasing condo units or new property for common use
  • Construction defect litigations against condo developers
  • HOA reserve and Condo reserve funding
  • Condo Association elevator repairs and replacement
  • Condo Association brick re-pointing
  • Condo Association roof replacements
  • new heating and plumbing, air conditions, boilers, windows for Condo Associations
  • Condo Association building lobby renovations
  • HOA parking lot repairs and re-paving
  • Condo building or repairing water, sewer and electricty infrastructure
  • Refinancing of exisiting HOA loans or condo association loans
  • Condo Association building or repair of common areas including community centers, tennis courts, golf courses, club houses, and other facilities.

HOA Loan and Condo Association Loan providers usually work with condo associations to provide innovative HOA loan structures to just about any situation. Other solutions include a Condo Association Credit Lines which HOAs can tap at their discretion to increase their cash flow in the form of condo reserves.

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How Will Bankruptcy Effect an HOA Loan?


Although the HOA Loan or Condo Asssociation Loan provider can minimize the risk, the tender must always ask itself the question, what if the condo association declared bankruptcy? Instances of community association bankruptcy are few, but there is some precedent. In the recent case of In re Condominium Association of Plaza Towers South Inc., 43 Br. 18 (S.D. Fla., Aug. 30, 1984), a U.S. Bankruptcy Court held that a condominium association may indeed file a Chapter 11 bankruptcy for reorganization.

However, almost no foreseeable circumstances would a condominium association be able to file a Chapter 7 for liquidation. The association must continue its statutory requirements to maintain the property. Furthermore, the record owners will continue to be legally responsible for the assessment whether or not units are inhabited. In fact, the lender should consider the association more in terms of a governmental unit, such as a city or county, that declares bankruptcy. A government has taxing power and that taxing power can be used to raise revenue to settle debts. There is also indication from other case law involving community associations that a court would order the association to look to its unit owners in the form of increased special assessments to settle its debts. I conclude, therefore, that the chances of a community association filing for bankruptcy are very small. Even if a bankruptcy did occur, it would be a Chapter 11 reorganization which would be resolved in a relatively short time because a court would look to the assessment or taxing power of the association to place the condo association back on a sound financial footing.


Assessment Problems That HOA Loans Can Fix

Problems with Special Assessments

Faced with the fiduciary duty to maintain the property, the board of directors can propose a large one-time special assessment to the membership to pay for the needed improvement. Such a special assessment can become a volatile political question among the members of the community association. Many times the documents will require at least a two-thirds vote of the membership to impose a special assessment. Therefore, if the board of directors cannot convince the membership of the need for a special assessment or if members simply vote against it because they cannot afford; such a lump sum special assessment, the board of directors finds itself between the proverbial rock and a hard place. On one hand, it has a fiduciary duty to maintain the community, but, on the other hand, it might not be able to muster owner support for a one-time special assessment.

Complicating the board's position under such circumstances is the fact that delay in making capital improvements will often prove even costlier because of deteriorating conditions in the capital resource. The board's logical recourse is to borrow the needed funds.

Of course, seeking an outside loan will provide the association with a chance to make the capital improvement or replacement immediately and pay the loan back over time through the condo association's special assessment process.



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