How to Prepare Before Applying for a Community Association or HOA Loan
March 21, 2022
Many community associations contemplating large-scale capital improvements first look to fund their needs with cash reserves. While a 100% funded HOA or community association reserve fund is ideal, many associations aren’t fully funded. For day-to-day operations, a good rule of thumb is that maintaining at least 70% reserve funding is adequate for meeting the National Reserve Study standard of reserve adequacy, according to Association Reserves, a leading reserve study provider.
For one-time or unexpected projects, an alternative to depleting your reserves is to obtain a loan with a bank that specializes in association lending. The following overview provides a basic game plan for financing your association’s capital improvement with loan funds.
Step 1: Gain borrowing approval
The first step is to contact your association’s management company and attorney to assess the steps to obtain approval to enter into a loan. Your loan will be secured by an assignment of the association’s assessments. Therefore, the association’s governing documents must permit it to enter into a loan and pledge its assessments as security.
Step 2: Determine a repayment plan
Next, the association needs to determine what means you will use to repay the loan. For smaller loans, an increase to regular monthly assessments may be a feasible way to make loan payments. Another option could be implementing a special assessment wherein each unit owner would pay upfront or participate in the loan program.
In either case, you’ll need to consider the board or homeowner approval(s) necessary to implement the desired repayment structure. You won’t need to have the structure in place before you apply for the loan, but in most cases, the structure will have to be approved before closing the loan. However, putting an increased regular assessment or special assessment in place before you apply for a loan can demonstrate to your bank that your association has both community support and the ability to repay the loan.
Step 3: Choose the type of association loan
When applying for a loan, your bank will want to know what type of loan and loan term you’re seeking. For large, lengthy projects, your bank will likely offer the option of entering into a non-revolving line of credit for the construction period. These lines of credit typically last six to 24 months. During that time, you’ll make interest-only payments on the amount drawn.
When construction ends, the line will convert to a fully amortizing term loan. A typical term loan is for five to 15 years. It is important that the loan length not exceed the useful life of the financed improvements — you don’t want to be paying for improvements that have outlived their lifespan. If the project is smaller or short-term, it may make sense to forego the draw period and immediately enter into a term loan. The sooner you begin paying the principal, the sooner your association pays off the loan.
Step 4: Prepare for the application process
When your bank evaluates a loan request, it may use several key metrics to gauge your association’s credit risk and ability to repay the loan. Some factors the bank may consider during the underwriting process include:
• Delinquency. Banks consider the number of accounts and the total amount of delinquencies. Many banks allow no more than 10% of accounts to be delinquent for 60+ days. Strong credit means your association’s delinquency rate is less than 5%.
• Liquidity. This measure considers your association’s cash amount as a percentage of annual assessments and annual debt service. Many banks have a minimum liquidity requirement of 20% of the association’s annual assessments. With strong credit, your liquidity levels are greater than 50% with at least one year of debt service.
• Size. More units or homes provide a diversified cash flow stream.
• Assessment increases. Large increases may cause delinquencies to rise. Strong credit involves increases of less than 25%. If a significant increase is necessary, implementing it before applying for the loan can mitigate your risk.
• Annual assessments related to market value. Annual assessments should not be greater than 10% of the unit value. Strong credit comes with yearly assessments that are less than 2% of market value.
• Owner occupancy and concentration. A high percentage of investors not living in their respective units poses more borrowing risk. Banks consider an association to have strong credit when more than 80% of units are owner-occupied, and multiple-unit owners control less than 10% of the units. Banks may consider an association to have weak credit when less than 60% of units are owner-occupied, and multiple-unit owners control more than 20% of the units.
• Management and capital planning. Ideally, your association will have an external professional management company with experience managing similar capital improvements. Having a professional reserve study that is at least partially funded indicates prudent financial planning.
If your association has ratings of fair to strong in most of the factors above, you will have higher chances of being approved for a loan.
For a borrowing process that takes into account your unique needs, with expert bankers who can answer all of your questions and guide you through the application process, look for a bank with deep experience in the community association sector. To learn more, contact your Alliance Association Bank relationship manager or find out more about what our bank can offer associations like yours.