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Borrow or Assess? A Guide to Community Association Loans

When the time comes for major capital item repair, replacement, or restoration, an association has 3 basic options available to it to finance the project: reserve funds, special assessments, or obtaining a bank loan.

In Ohio, community associations are required under state law to fully fund a reserve account OR obtain a yearly majority vote from the owners waiving this requirement. While fully funding the association’s reserve account is ideal, as it means the funds necessary for repair or replacement projects will be available, it is not always realistic. Without fully funding an association may be faced with a situation where work is required, but there are insufficient funds to pay for the project. When faced with this problem, an association must choose between issuing a special assessment or obtaining a bank loan to fund the project. Because special assessments can cause significant financial burdens on the owners, some associations choose to finance projects through a bank loan to spread the financial burden out over a number of years.

A loan taken out by the association is the responsibility of the association to repay, not the individual owners. Unlike a loan taken out by an individual, where a piece of property or other asset can be pledged as collateral, community associations do not typically hold title to real property. The property that is held by the association, the common elements, is likely to have little value as collateral due to it being subjected to numerous deed restrictions which can significantly limit its marketability.

As a result, most associations pledge their rights to future assessments or lien rights as collateral. State law restricts associations from assigning these rights without explicit authority to do so being contained in the association’s governing documents. Should this authority be absent from the governing documents, an amendment must be passed by the ownership granting the board the authority to assign these rights.

Once it is established that the board has the authority to enter into a bank loan and assign future assessment or lien rights to secure the loan, the board must choose a lending institution. Like any other service or product, the board should talk to a number of banks to compare the terms of the prospective loans. Terms such as interest rate, early payment penalties, length of repayment period, etc., will vary from bank to bank. Before selecting a bank, the board should ensure that it has done its due diligence and is making a decision that is in the best interest of the association and its members.

Once the board has reviewed the proposals, and a bank has been selected, the application process begins. When reviewing loan applications, a bank’s primary concern is the financial health of the association. As a result, the bank will request a number of corporate records for examination prior to finalizing the loan to ensure the association is credit worthy. These documents or information may include:

  • Governing Documents
  • Board Meeting Minutes
  • Up-to-date Financial Statements
  • Delinquency Reports
  • Current Approved Budget
  • Recent Audits
  • Recent Reserve Study
  • 2-3 Years of Tax Returns
  • Collection Policy
  • Owner/Occupant vs. Tenant percentages

Unfortunately, associations with 20 or less units/lots, may find difficulty in securing a loan through traditional large lending institutions. Smaller associations can be viewed as a greater lending risk due to the relatively small pool of owners available for the association to spread out the cost of repayment. As a result, some banks will deny an otherwise qualified association simply based on size and fear of potential default. Should you find yourself in this situation, it is suggested to talk to smaller lending institutions, like a local credit union, which may be more willing to work with smaller associations.

While bank loans provide the benefit of allowing the costs of major repairs or replacement to be spread out over a number of years and alleviating the immediate financial impact on the owners, there are limitations. Prior to obtaining a loan, the board should consider that interest will be applied to the loan, meaning owners will ultimately pay more in the long run than if a special assessment were issued. For minor or medium-sized expenses that owners can reasonably afford immediately, a special assessment may be more cost-effective. The right choice will depend on the nature of the expense, the financial health of the association, and the financial circumstances of the owners.

If your association is considering a bank loan, it is strongly recommended that a board contact an attorney if you have any questions about the associations authority to enter into a loan agreement, the loan process, or to review the terms of the loan agreement. A review of the loan terms prior to signing can help identify potential issues and grant your association the ability to negotiate terms to better protect the community’s interest.

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