First Steps in Preparing to Undertake a Loan

For community associations contemplating large-scale capital projects, an alternative to funding with cash reserves, is to contract a loan with a bank that specializes in association lending. The following overview provides a basic game plan for undertaking such a task.

The first step will be to contact the association’s management company and attorney and assess what steps need to be taken in order to obtain the necessary approval to enter into a loan. The bank’s primary security for these loans is an assignment of the association’s income (including assessments), and therefore it will be necessary that the governing documents of the association permit them to enter into a loan as well as pledge their income as security.

Once the association’s ability to enter into a loan agreement is confirmed, the association needs to determine what means will be used 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 to implement a special assessment wherein each unit owner would pay up front or participate in the loan program. In either case board or homeowner approval(s) may be necessary to implement the desired repayment structure and must be considered. It is not necessary to have said structure implemented prior to underwriting the loan, but in most cases the structure will have to be approved and implemented before closing the loan. That being said, implementing an increased regular assessment or a special assessment, prior to obtaining a loan, can be a good way to demonstrate to a bank that the association has both community support and the ability to repay the debt.

When applying for a loan the bank will want to know the type of loan and term being sought. For large and lengthy projects there will most likely be the option of entering into a non-revolving line of credit for the construction period.  These lines of credit are typically six to twenty-four months, and during that time interest only payments will be made on the amount drawn. Upon expiration or at construction end, the line will be converted to a fully amortizing term loan. A typical term loan will be from five to fifteen years in length. It is important that the loan length not exceed the useful life of the improvements being financed. Alternatively, if the project is short-term or small in size, it may make sense to forego the draw period and enter into a term loan immediately. 

When a bank evaluates a loan request, there are some key metrics that may be used to gauge the credit risk of the association. The following are some factors that a bank may consider during the underwriting process.

Delinquency

• Number of accounts and total amount of delinquencies.
• Many banks have a maximum rate of 10% for number of units aged 60+ days.
• Strong credit – Delinquency rate less than 5%.

Liquidity

• Amount of cash 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.
• Strong credit – Liquidity levels greater than 50% and at least one year of debt service.

Size

• Community should have at least 25+ units

Assessment Increase

• Annualized loan payments should not be more than 100% of annual assessment income
• Anything below 50% of this same ratio would be considered a "strong credit" 

Debt Per Unit Value/Market Value

• Total debt per unit should not be greater than 10% of the unit value.
• Strong credit – Annual assessments less than 2% of market value.

Owner Occupancy and Concentration

• A high percentage of investors not living in their respective units poses more risk.
• An association should be at least 60% owner-occupied.
• Strong credit – Over 80% owner-occupied; individual unit owner percentage should not exceed 10%.

Management and Capital Planning

• Strong external professional management company with experience in managing similar projects is desirable.
• Professional reserve study that is at least partially funded indicates prudent financial planning.

Ratings of fair to strong in most of the factors above by an association improve their chances of being approved for a loan.

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