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Accelerate Debt Repayment or keeping building Reserve Fund

Started by KellyM3 • 16 replies • 1762 views

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KellyM3 (North Carolina)
Posts: 2,239
Posted:
Our HOA has a debt that financed some emergency renovations because we didn't have our Reserve Funds built to the levels needed to avoid obtaining a loan. We're correcting that situation now but, of course, it takes time and spending restraint.

To me, a loan is essentially a Reserve Fund mechanism except you tapped a bank's cash over your own account, pushing the Reserve "negative" until you catch up the expense. So, with our Reserve Fund getting relatively healthy in comparison to the debt amount, is it better to maintain the current "as is" monthly payment on the loan AND preserve the monthly "payment" into our growing Reserve Fund or set a goal for a Reserve Fund amount, then direct the otherwise monthly payment for savings towards an extra principal payment?

Of course, every situation is different and in my personal finances, I tackle debt with a vengeance once I have some savings cushion (maybe not all I need but enough for 90% of contingencies). I'm honestly torn as to the philosophically prudent course of slowly paying debt and slowly building Reserve Funds versus quickly paying debt and freezing Reserve Fund growth until debt is paid.

Otherwise, our debt lingers into 2014.

Generally thoughts are appreciated
MaryA1 (Arizona)
Posts: 7,043
Posted:
Kelly,

Your reserve fund amount should be based upon what your reserve study dictates. If you are fully funded (at 100%), only then could you discontinue putting monthly payments into this account, but only until the loan is paid off. But, if your reserve fund is not fully funded (or very near to being) the BOD should continue to budget for the loan payment and the reserve fund payment. If you let your reserve fund dwindle you may find yourself in the same boat you were in when you took out the loan. Frankly, I'm not a fan of assn's obtaining loans. In fact, this can only be done if your docs allow it. I'm sure you're aware that if you'd asked the members to approve a special assessment you wouldn't have this loan to repay. But, whether it's a loan or a special assessment it all boils down to poor planning on the part of the BOD.
KellyM3 (North Carolina)
Posts: 2,239
Posted:
Thanks, Mary...

Our Master Association faces challenges in present time and it stems from fiscal policy dating back several years ago, apparently through the 1990's. Previous versions of our board apparently considered the notion of not maintaining amenities as a strategy for NOT raising dues. The result were dues kept low but the proverbial wind-up of a ticking financial time bomb occurred. I tell inquisitive property owners that it's like they bought a new car and never could financially justify changing the oil or tires....ever!

The result was as you can imagine....collossal and "emergency" renovations and rehabilitation of our pool and clubhouse in recent years before a majority of sitting board was serving. I commend my board's willingness to begin restoring and then protecting our community's existing assets but it inherited a tough situation and a property owner perspective that dues don't need to rise because they previously never did. Loans aren't good but they saved an assessment (which we need 70% direct property owner approval) at the expense, essentially, of half our "reserve fund monthly allocation" redirecting towards debt service. It can't and shouldn't happen again or we'll be petitioning for that 70% support in the midst of recession.

In HOA affairs, what you leave behind when you leave your office is certainly inherited, "warts" and all, by the new board members whose philosophy, and often volunteer legacy, is debt management and maintenance over amenity growth and enhancement - the "fun" stuff.

SusanW1 (Michigan)
Posts: 5,202
Posted:
Since the Reserve Fund should protect several categories, using it all for just a few projects puts all others at risk. I think you handled this the best way possible.

I think that ALL boards should be looking at themselves and asking "In 10, 20 or even 30 years from now, what will the board think of the job we are doing today?"
JonD1
Posts: 2,350
Posted:
Kelly:

I would wonder what interest rate are you paying on this loan?
Since when?
And up to tdoay you have paid how much in interest?
And through 2014 you will have paid how much total in interest?

And your reserve accounts are now invested where?
Rate of return?

And through 2014 your return on this investment would be?

How much do you owe on the loan?
How much do you presently hold in your reserve accounts?

In my mind only with this information could I make a suggestion as to which course of action might be in the best interest of your property.

How much is this loan costing you till 2014?
Do you see any need up till 2014 for your reserves?
Will paying off your loan deplete your reserves?

Is there a pre-payment penalty on your loan?
KellyM3 (North Carolina)
Posts: 2,239
Posted:
Jon,

It's a 6-year term at 7.5%. We opened the loan on Sept. 10, 2008.

Since our first payment in 9/08 thru 6/09 - we have paid $5,822.28 in interest payments. (one property's yearly dues total $453.60 or $37.80 per month)

Our current Reserve Fund is parked in a money market account "because we never know when we'll need liquid cash."
Reserve Fund rate of return is less than 1%

I consider a return on the Reserve Fund investment practically nil if we don't move some funds to a CD, a battle I've lost for now.

We owe approximately $56,422 on the loan after the June 2009 payment. (We leveraged all of an emergency repair in 2008 but we could've halved the debt by paying cash and borrowed less. We chose to borrow and still build cash reserves, but at a slower rate)

Our reserve funds sit at $46,890 as of June 2009.

The loan carries no pre-payment penalty.

So, we're in a negative equity situation but will emerge around Nov/Dec. 2009 if we don't spend a dime of the Reserve Fund. That's becoming very difficult as property needs are arising and the ability to convert dilapidated amenities (like a closed tennis court) into a new feature (off-leash pet park) could be performed for a couple of thousand bucks while removing a $40,000 Reserve Fund item as the tennis court would vanish.

AnnJ2 (Colorado)
Posts: 120
Posted:
I am not a financial advisor or banker but I would say that the argument to move money to CD's to get at least something needs to be made stronger. Start with baby steps and use small amounts in CD's staggered 3, 6, 9 and 12 months leaving some funds in the money market for "liquidity". some do not understand that with good budgeting practices and good knowledge of your community you can "guess" (hate to use that word) as to what you are going to have to spend reserve monies on over at least the next 6 months if not longer. CD's are liquid too to an extent that if planning is done well then any loss to the CD is truly emergency funds need and you had to close a CD. You don't lose principal and with a money market paying less than 1% how much actual financial risk would the association be taking if they had to cash out a CD early? And with staggered CD's something is always coming due in 3 months.

Maybe someone else with a finance background in on here and can better advise. But this is the strategy we give our clients.
AnnJ2 (Colorado)
Posts: 120
Posted:
One further thought, have you looked at refinancing the debt with rates coming down you might be able to do that to reduce the interest pay out over the life of the loan. Refinance and then pay the same payment which would mean that more goes toward principal paying off sooner with less interest without reducing the contribution to reserves that you are currently doing to pay the loan off faster.
KirkW1 (Texas)
Posts: 1,665
Posted:
For what it is worth, I would not hold off repayment of the equity in your loan until you have 100% funding in your reserves.

What I would do is look to the reserve study (or get it if you don't have one). From there I would look to try and run a balance between meeting the expected needs and paying off the loan as quickly as possible. Your investments won't earn the interest rate your paying. At the same time, it is best to not have to borrow again. (You may not get the loan the next time for some reason or other.)

From the reserve money standpoint, converting a tennis court into a dog park makes sense. The cost of conversion is much less then the cost of repair/replacement of the court. But the change in use should reflect a general consensus of the people. I would not do it if even only 45% of the people wanted to retain the courts (assuming there was some use of the courts).

Then again, I don't understand why a tennis court needs to cost $40,000. There was a time when you could provide a surface that was not perhaps as nice as the pros play on and people would appreciate it. Perhaps nothing more then a nice concrete surface or maybe even just a blacktop surface.
KellyM3 (North Carolina)
Posts: 2,239
Posted:

The argument for placing Reserve Funds into a CD should be a recurring discussion. I think as our reserve cash grows, acceptance of keeping some "liquid" while placing the other portion into a CD will be an acceptable compromise. I've consider a CD Ladder for my personal investing but haven't thought it may apply to Reserve Fund money. Good idea!

Our Reserve Study, which was professionally produced, is antiquated in that it was written in 1998. Since then, we've learned that the nearby streets are publicly maintained, not private streets (Reserve savings = $200,000) and other such changes of use and changes of responsibility. Our board really needs to re-craft a basic Reserve Study. The study is our guideline still but it's needs updating.

Regarding those tennis courts, the long term strategy, apparently, has been that non-maintenance is a money saving strategy. Thus, those courts need a true overhaul, with cracks in the asphalt and now plants growing through the cracks. In a previous decade, those courts were pristine. Now, the town we're in features superb courts that make any strategy of us cutting corners on court overhauls practically moot. The courts are pad locked currently and there hasn't been a tennis game played on them since, at least, Spring of 2005. So, its use is zilch and will forever be zilch unless we drop most of our current reserve funding into a new tennis court. There are more pet owners than tennis players in our community, bar none. The community was built in 1985 when tennis was an "in" thing. Right now, it's "no use" for the courts over a modified use. There has been no vocal opposition. What I've heard is "Don't raise my HOA dues but otherwise, it sounds fine."

Our overall community is very apathetic to HOA business, as if it isn't their worry and it isn't their property. One homeowner told me that previous boards were so lackluster and sub-par in managing the amenities and keeping them nice that they gave up hope for participating. That said, our park, lake, pool and clubhouse are in good shape and people enjoy them. Those courts are the final hurdle so don't let me run down the condition of our amenities by writing with a dramatic flair. The major repairs were undertaken at the point they HAD to be completed so services have never been interrupted.

If we convert the tennis courts into a new use and reset the Reserve Fund savings clock on it, our next big expense is a .62 mile long asphalt walkway around our lake. It's expensive and needs constant patching here and there, but I doubt we'll absolutely tear up all the asphalt and repave from the literal ground up, again, despite the Reserve Fund being there to completely "replace" the cost of the walkway.

If all goes well by the end of 2009 our biggest amenities will be updated and we enter, hopefully, an era of maintenance:

1. Pool - completely rebuilt 5 years ago
2. Club - core overhaul complete in 2008 (other work desired but not necessarily "core" to the club's function)
3. Tennis Court - converted to off-leash area (professionally managed), courts removed from our books
4. Paved Walkway - will always need spot maintenance but I don't see all .62 miles of it crumbled in one day, at one time.

All said, we'll still have the debt but our Reserve Fund will continue growing about $1,400 per month. The park might need a new bench but is basically grass and simply needs a good maintenance contract, which we keep as a core service.

MaryA1 (Arizona)
Posts: 7,043
Posted:
Kelly,

It's good to hear that you now have a more proactive board. Regarding the reserve study, I believe it's time for an update. We update our every 2-3 years. Laddering CD's is a good way of investing Reserve monies. In this market, 6 mo CD's are the most prudent! It's also a good idea to keep a certain % in a money market account so you won't have to cash in a CD b/4 maturity to pay for a reserve project. My assn keeps a rather large balance in our operating account so we can also use that $$$ until a CD comes due, if need be.

Regardless of what the members think, the BOD needs to make decisions based upon what is good for the whole assn, not just the naysayer members. You're always going to have a certain number of members who don't agree with you, regardless of what the issue is.

I would suggest that you keep depositing the $1,400 each mo into the resreve fund, at least until a reserve study update is completed. W/O the need to maintain the roads, there may be a sizeable reduction which can be applied to the loan. In the future, hopefully there won't be a need to take out a loan or even call for a special assessment. And, that is the main purpose for a reserve fund!
KirkW1 (Texas)
Posts: 1,665
Posted:
It sounds to me like things are well under control. As for the track there is a good chance that at least one time you can simply lay asphalt over the top of what is there without ripping up the existing asphalt.

I think your association could probably save money if they forgo 100% funding of the long term portion of the Reserves in favor of paying off the loan quicker as long as they will shift the amount that was going to the loan into the Reserves once the loan is paid off. (So if you were say paying $1000 a month in loan and $1400 a month into the Reserve you could shift $400 into the loan to pay it off quicker as long as you put the full $2400 into the Reserves until 100% funded.)
DanaB1 (Connecticut)
Posts: 319
Posted:
1) I'd look into a refi, you can get a 5 year loan at 6% fixed with no closing costs through a national bank that deals with HOA's and Condo's.

2) Even if you don't do number 1 then I'd stay with your current loan and stay building reserves. Because if you rush the loan payments and then need the reserve money and don't have it around the year 2011 or beyond?????? I figure by that time we'll be up to our eyeballs in inflation and high interest rates. Not a good time to have to borrow.

3) I think it was silly to have ever paved the path around the lake to begin with.......stone dust yes, asphalt no. Do you have tree's near the path? Are the roots breaking the asphalt? No matter the reason it was dumb for the to pave it. Too labor intensive to put in the first time and to repair every time thereafter. How many people use it? A nice hard packed stone dust is great for runners, dog walkers, bikers........... just no skate boarding.

Don't feel bad about cleaning up someone else's mess. It is fun to be on a "new" board that replaced the "old" board and try to get fees to where they need to be to get you out of the financial quagmire that 20 or 25 years of bad decisions put you in, isn't it? My God, it's a beautiful thing. All that work you get to do.......and for FREE no less.

That's when I love to hear the manager or attorney say, "Man, we've got a lot of work to do here." Yeah, at least their getting paid. I luv my job!!!! :-)

Stay positive!
KellyM3 (North Carolina)
Posts: 2,239
Posted:
What national banks offer HOA loans and especially re-financing with low or no closing costs?

Being new to the HOA board service, I learn a little every day and figured you needed to loan money from local or community banks.

MaryA1 (Arizona)
Posts: 7,043
Posted:
Kelly,

There is a bank which specializes in HOAs:

"Community Association Banc (a division of Mutual of Omaha Bank) is uniquely dedicated to providing comprehensive banking and financial management services to homeowner associations and other common interest communities."

Of course it doesn't hurt to develop a relationship with a local bank. My assn has an account with a small local bank. This bank has the CDAR program whereby they will go out and invest your $$$ in CDs with other banks offering good interest rates. This allows you to deposit more than the FDIC ins amount with the bank but still be covered by the ins because the money is being invested with other banks by the bank. We have a sizeable amount of money on deposit with this bank, so I like to think we would get a good interest rate on a loan.
DanaB1 (Connecticut)
Posts: 319
Posted:
I wasn't sure if it was proper protocol to mention them by name on the forum, I was going to have Kelly email me. But yes, them. There is also a bank that is a sponsor to this website; look to the column to the left or http://www.ncb.coop/hoa

:-)
AnnJ2 (Colorado)
Posts: 120
Posted:
We use RBC Dain Rauscher they ahve a state division that specializes in HOA's and other on and not for profits they may have teh same in your state too.

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