By Kathy Danforth / Published August 2018
Whether a community anticipated expenses or had a charge thrust upon them, there are times when an association may consider borrowing money. Cesar de la Noval with Executive National Bank comments, “If your community has little to no reserves and does not want to implement a special assessment, this may lead to a loan, especially if there is an urgent project to be completed. Ultimately, it all comes down to one simple question: Can your association afford to wait until monies are collected from the homeowners while the property is in disrepair, or should your association get a loan and start the repairs as soon as possible? It’s important to remember that the longer you wait, the bigger your liability may be.” De la Noval points out, “Most loans are used for repairs that need to be addressed urgently, but they can also be used for upgrades or improvements. Most commonly, loans are used for roof replacement, windows and doors, concrete restoration, elevators, or 30- and 40-year recertification.”
Richard Alfonso with U. S. Century Bank shares, “Communities usually find themselves in a position for a loan for two primary reasons: 1) The association has not properly maintained their reserves over the years to adequately fund routine repairs and maintenance of the property; 2) Unexpected events, such as a hurricane, have caused damage to the property, and repairs need to be made prior to the insurance company issuing a check and/or to cover the insurance deductible. For those associations which have chosen not to fund reserves, a loan allows them the opportunity to perform the necessary repairs or upgrades and to be special assessed the exact amount needed to complete the task. This at times can be a financial burden for some homeowners, but if they have chosen to live in a community with an association, they must understand that the maintenance and upkeep of all common areas is the responsibility of each homeowner. A loan provides the association with the benefit of being able to perform repairs without having to worry about maintaining a reserve. By no means are we advocating an association not have reserves; each board needs to properly assess their community and make plans that work for them. As a bank, our job is to try and find solutions that work for the community as well as for the bank, given the parameters of each association.”
Lisa Elkan with Alliance Association Bank, a division of Western Alliance Bank, notes that if an association is considering a loan, “There are some key factors to consider before getting too far into the lending process. The first step will be to determine if an association is allowed to borrow, and what actions need to take place in order to be able to legally proceed with a loan agreement.
“This is the stage where an association will want to involve their legal counsel, who will be familiar with the association’s governing documents as well as the state laws regarding associations. In order to close a loan, their association attorney will be asked to provide an opinion letter certifying the validity of the transaction, so an association should be aware of the following:
Once it has been determined that the association has the ability to enter into a loan agreement, the board of directors will need to determine what means will be used to repay the loan. For smaller loans, an increase to regular monthly assessments may be a feasible way to make loan payments. Another option could be to implement a special assessment wherein each unit owner would pay up front or participate in the loan.
“In either of these cases, board or homeowner approval(s) necessary to implement the desired repayment structure must be considered. It is not necessary to have the repayment structure implemented prior to applying for the loan, but in most cases, the repayment structure will have to be approved before closing. That being said, implementing an increased regular assessment or a special assessment prior to obtaining a loan may be a good way to demonstrate to a bank that an association has both community support and the ability to repay the loan.”
The board will need to consider the loan terms they feel fit their association. De la Noval says, “Your association should focus on obtaining the right balance of terms (repayment period) and monthly payments. The idea is to pay off the loan as soon as possible, but always take into consideration the affordability for the homeowners.”
According to Alfonso, “Since for the most part an association will need to pass a special assessment once to the homeowners for the project, it is important to ensure that the interest rate being charged is fixed for the entire term of the loan. Many financial institutions will offer a variable rate, which often is lower than a fixed rate; however, every time rates increase, the amount of the payment for the loan will increase as well. This in turn may require the board to continually pass increases to the special assessment to cover the new payments. A fixed rate may cost a little more in the beginning, but only one special assessment needs to be passed; and it will probably end up being cheaper by the end of the term of the loan.
“Regarding the term, the board may want to have as long a term as possible, so the special assessment can be as low as possible. This tactic—though it may appear to be a better deal for the owner—in fact costs more in interest. The association should try to maintain the loans within a five to seven-year term to keep the interest cost at an acceptable amount. The board needs to calculate the point of equilibrium which makes financial sense to the association, and in turn, the homeowner. It is important to point out that it is impossible to make everyone happy; this is a business decision for the good of ‘the entire association.’”
The type of project will influence the selection of the best financial arrangement. “For large, lengthy projects, there will most likely be the option of entering into a non-revolving line of credit for the construction period,” advises Elkan. “These lines are typically six to twenty-four months and give an association the option of interest-only payments during the construction period. Upon expiration or at the end of construction, the line will be converted to a fully amortizing term loan. A typical term loan will be from three to fifteen years in length. It is important that the loan length not exceed the useful life of the improvements being financed. Alternatively, if the project is short term or small, it may make sense to enter a term loan immediately.”
Kathleen Karpovich with Florida Community Bank explains, “Understanding the purpose is the first step to determine solutions when associations are considering lending options. The revolving line of credit provides access to funds for a set period and usually sets maturity with a floating rate of interest. During this set period, associations can draw down for specific needs, such as emergency remediation due to a hurricane. The repayment of a line of credit is usually interest only, with the principal outstanding due at the maturity of the line. (As this is a line of credit, the principal can be paid back prior to maturity.)
“The term loan option provides the ability to have full loan proceeds at the time of closing. This type of loan usually provides a full amortization of the loan amount with fixed monthly payments and a fixed rate of interest. This is a great tool to utilize for large purchases, annual expenses, and insurance premium financing.”
Karpovich explains, “The non-revolving line of credit option provides the best of both: the line of credit and the term loan. The loan is approved for a specific amount, with a draw period which converts to a term loan at the desired date. This type of loan is ideal for capital improvement projects, such as expansion or renovations to common areas, as well as hurricane remediation. Once you understand its purpose, you can determine your association’s best lending options.”
While the association is evaluating its needs, the bank will also be determining how attractive the association is as a credit risk. “The main factor that banks evaluate to qualify a community is the aged receivable report (or the delinquency report). This report will show the number of homeowners having problems paying their maintenance fees. It is also a testament of how aggressive the board of directors and management are about collecting overdue amounts. This is the most important criteria for a bank. It is highly recommended to work on lowering the delinquency ratios before going to a bank for a loan,” states de la Noval.
Elkan reports that in evaluating delinquencies banks are likely to consider the “number of accounts and total amount of delinquencies. Many banks have a maximum rate of 10 percent for the number of units aged 60-plus days.”
Another major consideration is the size of the additional assessment to the homeowners. According to Alfonso, “Special assessments should not exceed 100 percent of current maintenance fees. Even doubling the maintenance fee can be a financial hardship for most homeowners, and the board should be conscious of this when determining the size and scope of the project.”
Elkan describes additional elements that may factor into the approval process:
Alfonso recommends that condominium associations “maintain financial reporting as outlined in Florida Statute Chapter 718. The statute clearly outlines how financial statements should be prepared, depending on the size of the association. A properly prepared financial statement will assist tremendously with the credit approval process and will eliminate any ‘second guessing’ a homeowner may have with a given board.”
An association is a different financial animal from an individual or a business, so a board should find an experienced bank accordingly. De la Noval recounts, “When seeking a loan with a traditional bank, the loan officer is likely to ask questions such as, ‘What is the community year end profit? What is the FICO score and credit reports for the officers of the association?’ and more. These are all questions that will clearly indicate that you are dealing with the wrong bank. Do your research in advance and select a bank that works with community associations and is less likely to ask these kinds of questions. Find a bank that understands that a condominium is a non-profit entity and that board officers are unpaid volunteers; one that understands how a community operates and has the correct mix of products and services to create savings and efficiencies.”
Having money in the bank takes preparation; being in a strong position to get a loan also requires getting ready. Inevitably, repairs will happen, they will cost money, and those boards that plan wisely will minimize expense and friction in their community.
Cesar de la Noval is with Executive National Bank, Equal Housing Lender, Member FDIC. For more information, visit www.executivebank.com.
Richard Alfonso is with U.S. Century Bank, Equal Housing Lender, Member FDIC. For more information, visit www.uscentury.com.
Lisa Elkan is with Alliance Association Bank, Equal Housing Lender, Member FDIC. For more information, visit www.allianceassociationbank.com.
Kathleen Karpovich is with Florida Community Bank, Equal Housing Lender, Member FDIC. For more information, visit FloridaCommunityBank.com.