What Is an HOA Loan and How do They Work?
June 22, 2023
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A Guide To HOA Loans
Not every homeowners association (HOA) has the funds to afford unexpected expenses or repairs.
While it’s always better for an HOA to avoid external financing, this isn’t always realistic.
In certain situations, it may be necessary for an HOA to procure a loan.
Loans require proper planning and a clear understanding of expectations.
What is an HOA Loan?
An HOA loan is a sum of money an association borrows from a bank or creditor with the requirement that they pay back the money, plus interest, per the agreed-upon timeline. The interest is a percentage of the loan added to the principal.
It’s important to note that there are different kinds of HOA loans. Here are the four main ones:
- Line of Credit: This is a flexible loan with a preset borrowing limit. The bank or creditor will only charge interest on the funds borrowed. Because the interest rate is variable, monthly loan payments aren’t fixed. A line of credit typically has periods ranging from a year to five years.
A line of credit is best for HOAs with short-term issues. It can provide a stopgap until the HOA recovers. For example, a pre-established line of credit is incredibly helpful if a natural disaster hits your community, and you need to repair issues quickly.
- Line of Credit with Conversion: This is a loan with two phases. The loan is a line of credit in the first phase. Thus, the HOA pays interest on the funds borrowed.
At the end of 12 months or upon project completion, the loan becomes a standard term HOA loan. The bank or creditor sets the HOA loan rates, and the HOA must start repaying the principal and the interest till the end of the term period.
- Standard Term HOA Loan: The HOA receives the total loan amount from the creditor right away with this loan and then pays it back over the set term period. This loan is best for large repairs or land acquisition. The term period ranges from five to 15 years. The interest rate is fixed, meaning the HOA pays the same amount every month.
- Short-Term HOA Loan: This loan is identical to a standard term loan in most ways but with a shorter-term period. These loans range from three to 10 years.
The monthly loan payments are also higher, but HOAs can pay these back much quicker. There’s also less interest to pay off.
Can Every HOA Secure a Loan?
HOAs typically can secure a loan if their governing documents allow it. The governing documents, if created properly, will outline the board’s capacity to obtain a loan in certain circumstances and anything else related to obtaining credit. Many HOAs require a majority vote before the board can apply for a loan.
The authority to secure a loan can sometimes also be found in state laws. For example, Section 7140(I) of the California Corporations Code explains the power of a corporation to borrow money. And, in Indiana, there are specific conditions an HOA must take care of when securing a loan.
Some states don’t have laws regarding this authority. However, a reliable HOA will notify members before it ever takes out a loan. Most boards will also hold space for questions, concerns, and comments at an upcoming board meeting.
How do You Apply for an HOA Loan?
Most banks and creditors treat HOA loans like business loans, which means they have a principal plus interest structure. HOAs must take loans out under the association’s name and 15 years is typically the maximum term period for repayment.
Nowadays, you can apply for HOA loans in-person or online. The bank or creditor will usually ask a group of questions to assess credit risk and see if you meet HOA loan requirements. Expect questions like these:
- How many housing units are in your HOA?
- How many units are occupied by owners?
- How much do you charge for monthly assessments?
- What experience does your board have with capital planning?
- Will you raise monthly assessments to pay for this loan?
- How many delinquencies do you have?
The loan process typically takes about six months from application to finalization. The process involves multiple steps and multiple parties are involved, so the timing can vary.
Do Banks Require Collateral for HOA Loans?
Most HOAs are only allowed to borrow from reputable lenders like banks. Most banks don’t require collateral from HOAs or any other type of security to obtain HOA loans.
Obviously, an HOA should only apply for a loan if it has good reason to believe it can repay the loan. Financial planning is vital whenever an HOA considers a loan. The board should have a clear guide to pay back the loan and be able to articulate that plan to members.
Tips and Things to Keep in Mind
There are some things you should keep in mind if your HOA decides to obtain a loan:
- You want to work with a competent bank that specializes in community associations. It’s wise to only go to banks that have experience with HOAs. Do your research and make sure the bank you want to get the loan from knows how to work with HOAs.
- An HOA loan isn’t a solution to avoid raising dues. A loan will automatically require a raise in payments to account for operations, reserve funds, and the new loan payments.
- Side effects can impact homeowners. HOA debt can make it hard for homes in the community to qualify for certain mortgage or finance options. This can make it very difficult for homeowners to sell their property while hurting the value of properties in the communities. This, of course, highlights the importance of having a set plan to pay back the HOA loan in a timely manner.
- Spending the money from the loan wisely is obviously crucial. The board should have a clear plan for how to spend the money.
While taking on debt is rarely ideal, there are circumstances where it makes sense. As an HOA, it’s important to consider a loan from different angles.
The key part of taking out a loan is a specific plan to pay it back. A loan can help an HOA without causing issues if the proper planning and research is done.