When a Homeowner Association obtains a loan for common area projects like painting, roofing or asphalt overlays they have added a different dimension to their budget that should be handled carefully. Sometimes we are asked to include the loan repayment in the reserve study as an annual component expense; there are several reasons we do not include the loan repayment as a common area component:
Fannie Mae, Freddie Mac and FHA back the vast majority of loans for condominium refinances & sales in the United States. They have adopted guidelines which state an Association needs to allocated (at a minimum) 10% of their annual budget to the reserve account. This seems simple enough until a loan repayment scenario is introduced as they do not allow the loan repayment amount to be considered part of the reserve allocation; it must be deducted from the calculation. We have dealt with numerous Associations which have made the mistake of including the loan repayment and have been denied financing for refinances and/or sales of individual units. In all of these scenarios the Lender required a new study to be conducted which did not include the loan repayment amount in the reserve study as a common area component.
Annual disclosures to the community membership should be straight forward and as simple as possible. By combining reserve allocation rates and loan repayments together it is very difficult for a community member to understand what is going where. They will not typically have an understanding of the reserve account, reserve allocation rate or the loan amount and terms on the loan to make appropriate calculations to determine which the real reserve allocation rate is. The best solution is to pay the loan from the operating account or set up a separate loan repayment account which can be disclosed separately.
The credibility of the reserve study will also be in questions should these figures be intermingled. Again simplicity is best when trying to covey recommendations about concepts and projects which few people have a clear understanding of. Overall the credibility of the reserve study is compromised as it would take a reader some in depth knowledge of the reserve study process and findings to figure out that the component list comprised more than just the physical assets in the community. In our opinion the study loses credibility when these numbers are buried in the rest of the data.
National Reserve Study Standards
A loan repayment does not meet the four part test in National Reserve Study Standards which we follow in determining what components to include in the reserve study. This standard helps to standardize the reserve study process on a national scale and would prevent the issue of some companies including the loan payment in the study and others not; which could lead to very different outcomes and recommendations in the reserve study.
Additional Resources: Fannie Mae, Freddie Mac, FHA - 10% Rule