Insufficient HOA reserves can cause a ripple effect in any association. It may not seem like a big deal at first, but soon enough, underfunded reserves can lead to deferred maintenance, financial issues, and declining property values. It can even expose the association to liability risks.
What Does It Mean to Have Insufficient HOA Reserves?
When an HOA or condominium has inadequate reserves, it means the association doesn’t have enough money to cover projected capital repairs and replacements.
Every association has capital components and assets. Buildings, roofs, sidewalks, private roads, and amenities will all eventually deteriorate. Once these components reach the end of their useful life, the association must pay for repairs or replacements.
This is where the reserves come in. An HOA reserve fund is money the association sets aside to cover the costs of these repairs and replacements. Reserves are funded by the homeowners, with a portion of their regular dues allocated to the reserve account.
The legal requirement to fund reserves depends on state laws and the governing documents. In Illinois, condo associations are legally mandated to maintain reserves (765 ILCS 605/9). Board members should check their CC&Rs and bylaws for additional guidelines.
What Happens When HOA Reserves Are Not Enough?
Insufficient HOA reserves can trigger special assessments, deferred maintenance, mortgage issues, declining property values, and fiduciary liability. Let’s discuss each effect below.
1. Special Assessments
When an association doesn’t have sufficient reserves and a need for reserve funding arises, the board may be forced to impose special assessments. More often than not, these are large, sudden fees, sometimes reaching thousands of dollars per owner.
2. Deferred Maintenance
Insufficient HOA reserves can delay maintenance, repairs, and replacements. Board members may postpone necessary projects, causing structural damage and long-term deterioration. Not saving money now can end up costing the association more in future repairs.
3. Mortgage Issues
Lenders scrutinize association finances very closely. They look at the annual budget and reserve summaries. Weak reserves can lead to higher interest rates, stricter loan terms, and even outright rejection of loan applications from potential buyers.
4. Declining Property Values
Deferred maintenance, financial instability, and a shrinking pool of buyers can all cause property values to plummet. While the effect may not be immediate, insufficient HOA reserves can cause irreversible damage to an association’s property and reputation.
5. Fiduciary Liability
If an association is legally required to fund reserves, failure to do so can expose the HOA to liability. Worse yet, board members may even be found personally responsible for breaching their fiduciary duty.
What Percentage of HOA Dues Should Go to Reserves?
In general, the rule of thumb is to have reserves at least 70% funded, with around 15% to 40% of total dues allocated to the reserve fund.
Every association is different, so the percentage of HOA dues allocated to reserves can vary widely. Most experts recommend earmarking 15% to 40% of dues as reserve contributions, but it ultimately depends on several factors.
For one thing, an association’s age can affect reserve funding. Older properties usually have more aging components, thereby requiring higher contributions. These communities also usually have insufficient HOA reserves because of outdated practices.
Shared amenities are another factor that can influence reserve funding. Communities that operate swimming pools, elevators, or private roads tend to have more diverse needs. These associations must split the reserves and ensure there’s enough funding for all components.
In short, there is no universal answer to how much of dues must go to reserves. Instead of relying on a fixed number or percentage, associations must conduct a reserve study. This study takes into account all of the association’s financial and physical assets. From there, the study recommends a plan along with contribution targets.
For example, if a 50-unit association reserve study recommends setting aside $5,000 every year, then each unit must contribute $100 annually. This number is factored into the budget, not the other way around. Boards determine regular dues by projecting upcoming expenses, including reserve contributions.
Keep in mind that an HOA must hire a professional to conduct the reserve study. The board must not take it upon themselves.
How to Fix Underfunded HOA Reserves
To fix insufficient HOA reserves, board members should consider raising regular dues, levying special assessments, obtaining HOA loans, conducting a reserve study, or hiring an HOA management company. Most associations will need to employ a combination of two or more of these strategies.
1. Raise Regular Dues
Regular dues fund reserve contributions. If an association’s reserve balance is low, consider raising monthly dues to restore reserves to a healthy level.
2. Levy Special Assessments
Incremental increases work better with regular dues, but if an HOA needs money ASAP, special assessments are usually the better option. Of course, it is important to explain to homeowners why the special assessment is necessary to avoid pushback.
3. Obtain HOA Loans
If owners can’t pay a large special assessment in one go, boards should consider taking out a loan. Many banks specialize in HOA loans and lines of credit specifically designed for communities. A loan provides the association with an immediate cash injection and manageable repayment terms.
4. Conduct a Reserve Study
A reserve study analyzes the association’s physical and financial assets, including the current reserve balance, and creates a funding plan. This plan outlines the remaining useful lives of capital components, the costs of repairing or replacing them, and the amount the HOA must set aside each year to meet these obligations.
5. Hire an HOA Management Company
Many self-managed associations struggle to keep reserves stable. A professional management company can assist with reserve planning, calculations, and collections.
A Board Effort
Insufficient HOA reserves can negatively impact an association’s finances and property values. Boards must strive to maintain healthy reserves, ensuring the association has the capacity to meet its long-term financial needs. In doing so, they can maintain financial stability and protect homeowner investments.
Hillcrest offers HOA financial management services to communities in Chicago. Call us today at 630-627-3303 or contact us online to request a proposal!
RELATED ARTICLES:
- How HOA Reserve Funds Protect Your Community’s Future
- HOA Reserve Study: Protecting HOA And Condo Budgets
- Can The HOA Borrow From Reserve Funds?
