First Steps in Preparing to Undertake a Loan

Roof replacements, elevator upgrades, paving and structural repairs rarely happen on a convenient schedule. For many community associations, reserve accounts aren’t prepared to absorb the full cost when these needs arise, and association boards find themselves asking, “How can our association manage these unexpected capital costs?”

Cash reserves or a special assessment are not the only ways to cover these expenses. An association can also obtain HOA financing to complete a required project while making costs more manageable by spreading them over multiple years.

The borrowing process can be complex, and it takes preparation. These six questions will help HOAs and community associations prepare for the loan application process with confidence.

Is our association eligible to borrow? 

The first step before seeking financing is to verify that the governing documents give your association authority to borrow. Community association loans are generally secured by an assignment of the association’s assessment income rather than by individual owners’ homes. The governing documents therefore need to permit the association to borrow and to pledge assessment income as security.

A good place to start is to review the association’s governing documents and consult the association’s legal counsel. A lender’s security is an assignment of the association’s income, including assessments, so the documents must permit the association both to borrow and to pledge that income. Some allow it outright while others require a vote of the owners or an amendment first.

How do we repay the loan?

There are three common paths for repayment: 

1. Regular assessment increase: The association can raise regular monthly assessments to bolster annual cash flows, which can sometimes work for repayment on smaller loans.
2. Special assessment: Depending on governing documents, the association members can vote on a special assessment that owners may pay up front or over time through the loan. 
3. A combination of regular assessments and special assessments: Associations may use a special assessment to reduce the amount that must be financed and an increase in regular assessments to support ongoing loan payments or other recurring costs.

Board or owner approval may be required either way. In most cases, the repayment plan must be approved and in effect before closing on the loan. Putting the increase into effect early is one of the strongest signals a community association can send that shows a lender that the community supports the project and has a workable source of repayment.

What kind of loan fits the project? 

A loan’s structure depends on the size and length of the project. For a large, multiphase job, the common structure is a line of credit during construction, typically six to 24 months, with interest paid only on the amount drawn. When construction ends or the draw period expires, the balance converts to a term loan repaid on a set schedule, usually five to 15 years.

For a smaller or shorter project, a term loan from the start often makes more sense. In each case, the repayment period should not outlast the improvements. For example, a roof expected to last 20 years should not be paid off over 25 years.

What criteria does a bank evaluate?

A lender’s review typically includes a review of several key features that can indicate an association’s financial health:

• Delinquencies, or how many owners are behind and by how much. 
• Cash on hand, measured against a year of assessments and loan payments. 
• Community size, generally at least 25 units.
• Assessment burden, or how the new payment compares with income. Annual loan payments should not exceed annual assessment income.
• Total debt per unit, which should stay under 10% of what a unit is worth.
• Owner occupancy rate, ideally 60% or higher, with no single owner holding more than 10% of the units.
• Professional management to help support budgeting, collections and administration of a major project.
   

What makes an association a strong candidate for project financing? 

Stronger candidates often share several traits that tell banks they could be a good candidate for financing: 

• Low volume of delinquencies
• Cash above half of annual assessments plus a full year of loan payments
• New loan payments below half of assessment income
• Number of units within the community, how many are owner-occupied and how many are owned by the same person/entity
• Whether a special or one-time assessment has been or will need to be passed in order to repay the debt

Few associations are strong in every category, but ratings of fair to strong across most of the criteria can generally put an association in good standing for approval.

Who should be involved before we apply?

Three conversations should happen early: with the community manager, the association’s attorney and a lender experienced in community association financing.

The manager can help assemble financial and operating information. Legal counsel can confirm borrowing authority and approval requirements. A specialized lender can help the board understand potential structures, underwriting considerations and documentation needs before the association commits to a final financing plan. 

Lenders can also meet with owners to explain the loan process and how an association loan works. 

At Western Alliance Bank, we take a hands-on approach to lending. Our experienced bankers guide clients through every step of the loan application process, from the initial conversation and documentation review to underwriting and closing. We work closely with borrowers to understand their goals, answer questions and help identify the financing solution that best fits their needs.
Starting those conversations before project plans and assessments are locked in gives the association more room to identify and address potential issues.
 

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