Is it legal for an HOA to borrow from reserve funds? This is a question many board members ask. The answer, while important, isn’t as simple as a yes or no. There are several variables to consider, including the association’s ability to repay the loan. Jeopardizing the reserves can have severe consequences, even putting board members at risk of liability.
Can an HOA Borrow From the Reserve Fund?
In an HOA or condo community, the reserve fund plays a crucial role in preserving long-term financial health. The reserves pay for future repairs and replacements of major components. In Illinois, condominiums are even required by law to fund reserves (765 ILCS 605/9).
Whether or not an association can borrow money from HOA reserves depends on two things: state laws and the governing documents. It is essential to consider both of these before the board makes any decision.
Can an HOA Borrow From the Reserve Fund in Illinois?
There is no Illinois law that explicitly allows or addresses borrowing from the reserve fund. That said, reserves are intended for future capital repairs and replacements, not to cover operating shortfalls. Using them for something else can conflict with their intended purpose.
Additionally, board members have a fiduciary duty to act in the association’s best interest. If a board uses reserves improperly, it could be seen as poor financial planning and a breach of this duty.
Do Governing Documents Allow HOA Reserve Borrowing?
If state laws are silent, board members should refer to their governing documents for guidance. Most CC&Rs and bylaws restrict how the association can use the reserves.
If the HOA does borrow from the reserve fund, it must do so only temporarily. The CC&Rs and bylaws also typically require repayment. Other than that, board members must record the loan in writing.
In some communities, homeowner approval may be necessary, especially if the loan reaches a certain dollar amount or percentage. Even without a vote requirement, boards should still communicate the move with homeowners. This helps promote transparency and accountability, thereby improving trust.
Repayment After Borrowing From HOA Reserve Fund
Depending on their governing documents, some associations may be able to borrow from the reserves to cover operational shortfalls. That said, these loans must be temporary, which means the association must repay them within a set timeframe.
Many CC&Rs and bylaws require a written repayment plan. The board must strictly adhere to this plan or risk legal exposure. Of course, repaying the borrowed funds will necessitate a cash injection. Most of the time, associations raise money from dues or special assessments.
Risks of an HOA Borrowing From Reserves
Borrowing money from an association’s reserves comes with pitfalls. Understanding these risks will help the board make a more informed decision. Here are the possible consequences when HOAs borrow from the reserve fund.
1. Deferred Maintenance and Repairs
Reserves are meant to cover major repairs and replacements. When a board pulls money from reserves, it reduces the association’s ability to fund those projects.
If a roof, elevator, or roadway needs work sooner than expected, the association may not have enough funds. This often leads to delayed maintenance, which can worsen the problem and make it more expensive over time.
2. Potential Breach of Fiduciary Duty
Board members have a duty to act in the best interest of the association. Using reserve funds improperly can interfere with that duty, especially if the board does so without proper authority. Before long, owners may accuse the board of mismanagement, exposing the board to legal liability.
3. Cash Flow Problems
Borrowing from the reserves is often an indication of a larger problem. It usually means that there are underlying issues with the budget. Instead of fixing the root cause, borrowing reserve money is only a temporary solution. The association will continue to struggle with cash flow.
4. Loan and Insurance Complications
Lenders and insurance providers usually review the association’s finances before approving a loan or policy. When an HOA has low reserve balances or continuously borrows from the reserve fund, it raises red flags.
This will make it harder for the board to secure loans. Insurance providers may also offer unfavorable terms, higher deductibles, or more expensive premiums. Buyers may even think twice about moving into the community.
5. Loss of Trust or Confidence in the Board
Homeowners value transparency and financial stability. When the board uses the reserves improperly, owners may feel concerned about mismanagement. They may question the board’s decisions more often or challenge every project. This will make it more difficult for boards to continue operations.
Should an HOA Borrow From Reserve Fund? Alternatives to Consider
The decision to borrow from the reserves typically stems from an operational or budget shortfall. But there are other ways to inject cash into the association without touching the reserve fund. Here are the alternatives that associations should consider.
1. Regular Dues Increase
The most common move is to raise regular dues for homeowners. This gives the association immediate access to funding without compromising the reserves. Besides, the HOA is going to increase dues anyway to repay the borrowed reserves, so it may as well go straight to the source rather than take extra steps.
2. Special Assessments
Special assessments may not be popular among owners, but they do get the job done. When an association is in urgent need of funding, these assessments can help cover immediate expenses. Of course, board members must clearly explain the purpose of the added assessment to owners. This way, they can limit pushback.
3. Loans or Financing
Just like borrowing from reserves, loans must be repaid over time. The difference is that loans don’t jeopardize major capital repairs and replacements. They might carry interest charges, but they don’t pose the same risks.
4. Fundraisers
Fundraisers are a great way to earn extra income without increasing dues or charging special assessments. Boards can organize everything from car washes and bake sales to community festivals and entertainment nights. Associations can also rent out amenities, seek partnerships with vendors, or ask for sponsorships.
Can an HOA Borrow From Reserve Funds? Answered!
Many boards are tempted to borrow from the reserves to solve immediate cash flow needs, especially if the reserve fund is healthy. Yet, making this move is not always a good one, as the board’s authority has limitations. It is important to examine the decision from every viewpoint to avoid potentially breaching the board’s fiduciary duty.
Hillcrest offers HOA management services to communities in Chicago. Call us today at 630-627-3303 or contact us online to request a proposal!
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