The Effect Of A HOA Reserve Deficit On Homeowners

An HOA reserve deficit harms both the association and the homeowners who comprise it. Unfortunately, far too many HOAs have underfunded reserves or, worse yet, no reserves at all. While it may not seem like it initially, the ramifications of a reserve deficit can have a long-lasting negative impact.

What is a Reserve Deficit?

Homeowners associations are responsible for budgeting, accounting, and financial management. This includes maintaining a healthy reserve fund. The reserve fund consists of saved money allocated for the cost of major repairs and replacements in the future.

Different associations have different needs. As such, there is no dollar amount that universally applies to all HOA reserves. How much an HOA should have in its reserves at any given point in time will depend on the calculations and funding plan reflected in its reserve study. Ideally, an HOA should have at least a funding of 70% in its reserves.

An HOA reserve deficit occurs when an HOA does not have sufficient funds in its reserve account. When faced with a deficit, an HOA can encounter serious financial consequences. It can have a ripple effect, hindering not only the HOA’s finances but also the finances of homeowners.

HOA Reserve Fund Deficit vs Low Reserve Fund

An HOA reserve fund deficit is essentially the same as a low reserve fund. Since a reserve fund is akin to an association’s savings account, a low reserve fund is equivalent to having low savings.

How an HOA Reserve Deficit Affects Homeowners

A reserve shortage can have short-term and long-term effects on the HOA and its homeowners. It can even lead to irreversible damage, liability, and fatalities, as exhibited by the Surfside Tower Collapse in Florida.

Here are the potential consequences of an HOA reserve deficit.

1. Higher Financial Burden on Owners

Homeowners will likely experience a heavier strain on their finances. The HOA is responsible for common area maintenance and upkeep, including the cost of future repairs and replacements. Typically, an HOA would secure funding for this cost through its reserves. However, with insufficient reserves, the HOA will be forced to seek funds in other ways.

This is where homeowners come in. Homeowners contribute to the reserves on an incremental basis. However, when the time comes, an HOA will need to levy a hefty special assessment or significantly increase dues to make up for the deficit. These unexpected fees are an additional burden to homeowners, particularly those who rely on fixed incomes.

Moreover, if a homeowner fails to pay these charges, an HOA can take action against them. This includes imposing late or interest fees, filing lawsuits, placing liens on the home, and even initiating foreclosure proceedings.

2. Difficulty Selling Homes

Underfunded reserves can make it harder for homeowners to sell their homes. Potential buyers might think twice about buying property in an HOA with inadequate reserves. A reserve deficit shows that the HOA isn’t in a good financial place. With the threat of special assessments and higher dues in the future, buyers may not want to push through with the sale.

Lenders may also be reluctant to approve financing for a home if the HOA’s reserves are insufficient for the same reasons. Poorly funded reserves signal a lack of financial planning and unpredictability.

Beyond that, a reserve deficit can also bring down the home’s sale price. Potential buyers might negotiate for a lower price, citing the HOA’s low reserves and financial instability as a bargaining tool.

3. Lower Property Values

An HOA reserve deficit can also lead to lower property values. The desirability of an HOA community is influenced mainly by proper common area maintenance and upkeep. If an HOA doesn’t have the money to pay for repairs and replacements, common areas can quickly deteriorate. Potential buyers will feel apprehensive about buying into such a poorly maintained community. As a result, property values can plummet.

4. Legal Implications

Finally, homeowners can get involved in expensive and lengthy legal battles. Several states require associations to perform reserve studies regularly. These studies help ensure that an HOA’s reserves remain healthy.

If the HOA board neglects to follow this study to maintain its reserves, the board members can potentially face personal liability. A court can find the board members guilty of violating their fiduciary duties. As a result, homeowners will live in limbo as the legal battle, which can be very costly and time-consuming, continues.

How to Fund HOA Reserve Deficit

Homeowners associations with a reserve deficit can make things right if they act fast. By taking the necessary steps, an HOA can bring its reserves up to the appropriate level of funding.

Conduct a Reserve Study

First, an HOA should perform an initial reserve study or update its existing one. A reserve study evaluates the HOA’s finances and physical assets. It estimates the remaining useful life of each component and how much it will cost to repair or replace it.

This reserve study will also tell the HOA how much it needs to have in its reserves at any given time. It will also depict a funding plan stating how much owners must contribute. With a plan in place, the association can quickly get itself back on the right track.

Explore Funding Options

An HOA can’t simply pull money from its operating fund to transfer to its reserves. However, funding has to come from somewhere, usually the homeowners.

The HOA can explore one or more of three ways to make up for its reserve deficit:

• Raise HOA Fees. This is usually the best choice for an HOA, as it spreads out the payments to make them more manageable for homeowners. Of course, as with any increase, the board should expect mixed reactions from residents.
• Levy Special Assessments. Another option an HOA has is to levy a special assessment. Typically, an HOA will charge this assessment as a one-time fee, though incremental payments are also possible. It is important to check state laws and the governing documents, though, as there may be a limit on the amount an HOA can levy in special assessments. Sometimes, an HOA will also need a membership vote to approve a large assessment.
• Secure a Loan. The third option is to secure a loan or apply for a line of credit. This will involve a third-party financial institution. If an HOA needs funding urgently, this is usually the wisest option. However, an HOA must pay back the loan with interest, so it will still need to raise dues or levy a special assessment.

Hire a Financial Advisor or HOA Manager

Not all HOA board members have the capacity and expertise to manage a reserve deficit. Fortunately, they can hire a financial advisor or HOA manager to help with the situation.

All Things Considered

There is no upside to an HOA reserve deficit. When an HOA has insufficient reserves, it will only encounter setbacks. Thus, it is imperative to keep HOA reserves at an appropriate level of funding. This way, both the HOA and its homeowners can rest easy.

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