A homeowners association doesn't always have the best stories to tell when it comes to HOA reserve fund accounting.
Unfortunately, sometimes, reserve funds aren't enough to cover repair expenses. In some cases, treasurers use the reserved money to pay other bills. Also, some HOAs don't even have these funds.
However, properly handling a reserve fund is essential for a well-run HOA. What happens if the community must bear large unexpected expenses? Where would the money come from to fix major issues?
Since the regular dues are usually not enough to cover these unfortunate events, a reserve fund can prevent the HOA from falling into the red.
Additionally, during periods of economic uncertainty, reserve funds ensure that the association can operate and maintain properties in excellent condition for residents.
Therefore, without this reserve fund, an HOA may be forced to make hasty, unpopular financial decisions or delay repairs that are crucial to keeping the premises safe.
Do you want to know the best reserve fund accounting practices? Read on!
- An HOA reserve fund is intended to cover unexpected or anticipated but non-routine costs.
- It's managed by the development's governing board.
- The development's governing documents set rules on HOA reserve funds, including fees and how to use this money.
- HOAs must keep the reserve fund money in a separate bank account.
- Failing to have the reserve fund can hurt HOAs' finances in the short and long term.
- An HOA's reserve fund is different from an operating fund.
What Is an HOA Reserve Fund?
Understanding what a reserve fund is can be tricky if you're just starting off as a property or community association manager (CAM).
However, you can think of reserve funds as the money you save to pay for major repairs when there's unexpected damage, such as fixing a plumbing leak, for example.
An HOA often keeps these savings in "cash reserves" or "reserve accounts" since that money is used to cover large, unexpected, or non-routine common-area costs.
In other words, the reserve fund is money that the HOA sets aside and uses as a savings account to cover major expenses that may arise in the future.
Overall, the HOA's board of directors manages reserve funds, as it's part of its responsibility to keep properties in good condition and up to the contractual agreements with residents.
What Are HOA Reserve Funds Used For?
As mentioned, reserve funds can be used to cover large infrequent or non-routine repairs, such as fixing cracks on a pool or leaks on the clubhouse roof, replacing broken equipment in the fitness room, or purchasing a new water heater.
This money can also be used for expected or anticipated repairs, such as re-shingling an old roof.
However, it shouldn't be used to pay for routine repairs. Instead, HOAs should keep enough savings in a reserve fund to cover large infrequent expenses.
Differences Between HOA Reserve Fund Accounting and an Operating Fund
HOAs must also keep money in an operating fund, but is it part of the reserve fund?
Unlike the reserve fund, which must be used for nothing but non-routine or unexpected repairs, the operating fund covers day-to-day expenses. They may include maintenance services, utilities, landscaping, taxes, management fees, and insurance.
Every time a resident pays the monthly HOA fee, a portion goes to the operating fund while another portion, probably smaller, is set aside and kept as part of the reserve fund.
In addition, reserve funds and operating funds must be kept in different accounts – a saving account and a checking account, respectively.
Ideally, a homeowners association should have between one and three months' worth of operating funds in the checking account in order to keep the properties in good condition and have enough money to cover main expenses.
Both funds are important. If an HOA doesn't have operating funds, the community wouldn't be able to operate as it should on a daily basis. Also, when there aren't enough reserve funds, the association could have trouble covering major unexpected repairs or pursuing projects essential to its growth.
How Much Money Should an HOA Keep in a Reserve Fund?
All homeowners associations have different needs, sizes, expenses, and common elements. Therefore, there is no specific or ideal dollar amount.
However, a homeowners association's reserves are considered fully funded when they can cover the community's major expenditures for at least the next 20-30 years.
Some states have set a specific amount according to the HOA reserve fund laws. In Ohio, for example, reserve contributions must amount to at least 10% of the association's annual budget.
Additionally, properties with mortgages under Freddie Mac, FHA, and Fannie Mae governance are only required to have around 10% of the reserve funded.
In these cases, HOAs often must make a special assessment to cover the costs of a big repair, for example.
Often, governing documents contain information on when an HOA should keep in reserves. Some documents even set the reserve funding percent requirement at 85-90%.
As a general rule of thumb, HOAs usually make sure their reserve fund will make up at least 70% of their annual budget. In simple terms, if the reserve study shows that the community must have at least $60,000 in reserves in a year, the amount reserved must be at least $42,000.
These associations usually hire an outside accountant or HOA management company to prepare a reserve study and set out a long-term costs and repairs schedule.
With a reserve study, the accountant can anticipate whether an area needs to be repaired or renovated in a few years or estimate the costs of repairs over a five-year period.
As a result, this professional can advise the HOA about how much money must be collected in periodic dues to set an apportioned amount into the reserve fund each year.
However, the HOA's board has the last word, as members have a fiduciary duty to the association. In addition, board members must always act in good faith, with loyalty and honesty.
If you are a board member, you should always prioritize the community's needs. Some HOAs maintain a partially funded reserve to lower monthly fees for residents.
Other communities choose to budget for repairs or renovation projects instead of replacing property items to keep costs down and save.
Why Does an HOA Need to Have Enough Money in the Reserve Fund?
As mentioned, having a reserve fund allows homeowners associations to cover large unexpected expenses without falling into the red.
However, in order to understand why these communities must have enough cash in reserve, it is important to know the HOA's duties and responsibilities.
The development's governing documents usually detail the association's obligations. They often include bylaws, articles of incorporation, Covenants, Conditions, Restrictions, Easements (CC&Rs), and other separate regulations.
Typically, these documents state that HOAs must maintain, operate, repair, and replace the development's common areas as needed.
These "common areas" may include all areas on the property owned jointly by everyone who has purchased a home there, such as pools, parks, and clubhouses.
Depending on the development, common areas could include other spaces. In more upscale projects, they could be fountains, spas, and entrance gates, for example.
What Happens When an HOA Doesn't Have a Reserve Fund?
HOAs without reserve funds could face problems. If the community doesn't have enough money in reserves and a major expense emerges outside the general operations budget, how can it cover that expenditure?
In this scenario, an HOA can increase dues significantly right away. In addition, the association could levy special assessments.
However, most homeowners won't agree to those options. Many won't even be able to afford increased dues or pay a large amount at one time, as often happens when there is a special assessment.
Also, most of the time, both the raised dues and the special assessments are inefficient, as they only show the consequences of the HOA's lack of planning.
Therefore, board owners or community association managers should plan ahead and include future repair and replacement costs automatically in periodic dues.
If this happens, the reserve fund is properly maintained, and the community has enough money to cover sudden expenses that could be detrimental to its finances.
What Is a Special Assessment?
If there is not enough cash in the reserve fund, the HOA must conduct a special assessment.
This process allows the governing board to assess the costs of any repairs or replacements needed. Once the estimates are ready, members can divvy it up among homeowners or residents.
In these cases, HOAs can set an equal share that all residents must pay. Some determine the fee based on their units' square footage.
However, the development's board cannot call for a special assessment at any time. It's determined by the HOA's governing laws. Therefore, some associations need a vote to choose whether to make it.
How to Determine Fees for HOA Reserve Funds
Collecting money for homeowners association reserve funds depends on the community's fee structure for residents.
Since the HOA must also collect operation funds, the monthly fee that residents must pay should include enough money for regular maintenance and services.
In addition, this sum must include the money that the board plans to set aside for the reserve fund. However, to be more precise in determining how much cash is needed for this fund and what to lump into the fees, associations should conduct a reserve fund study.
What Is a Reserve Fund Study, and How Should HOAs Conduct It?
When an HOA creates a reserve fund for the first time or is reassessing an existing one, conducting this study can help them determine how much cash they should put away.
Generally, homeowners associations hire an outside firm to perform this reserve fund study.
These firms examine the property to determine if there are any areas that need repairs, renovations, or upgrades in the near or distant future.
After that, experts determine how much money the HOA would need to cover those repairs.
If they plan ahead, HOAs can create a financial strategy to fund their reserves based on the study's findings. This plan should include how much money they should put away, how much they should charge the homeowners to collect the sum, and how they should invest that money.
However, this reserve fund study should be performed from time to time to make sure there's always enough money in case a problem arises and the community needs to pay for a big repair or renovation.
Properties backed by a Fannie Mae, FHA, or Freddie Mac loan must conduct this study every two years.
Reserve Funds and State Regulations
HOAs must always follow the state regulations for reserve funds whenever they create, modify, or spend one.
However, these rules usually vary from state to state. In California, for example, there are specific regulations to combat fund abuse. In addition, HOAs must complete reserve studies every three years.
Additionally, this state allows HOAs to borrow against the reserve fund if it helps shore up the community's income as long as they pay the money within a year.
A reserve fund is essential for HOAs, as it allows communities to have enough money to cover emergency expenses or unforeseen repairs and renovations.
However, community association managers must know their state's laws to create, maintain, and spend this fund properly.
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Frequently Asked Questions
Why Should HOAs Keep the Reserve Fund In a Separate Account?
HOAs must hold reserve funds in separate accounts from operating funds and other amounts that the association collects.
It's called "fund balance accounting" and allows the HOA to manage and allocate funds for specific uses while keeping clear records of where the money is going.
However, there's a question most property owners still have in mind: why should HOAs keep the reserve fund in a separate account?
There are two key reasons:
- The IRS may consider the money to be taxable income to the HOA if it isn't set aside in a separate account.
- HOAs must keep track of the money they receive and spend since residents will always want to know where it is.
Can HOAs Invest the Reserve Fund Money?
Yes, they can! An HOA can invest part of the reserve money fund as long as there is enough money available to cover immediate needs.
What Are the Common Accounting Methods Used by HOAs?
To calculate reserve funds or keep track of the money collected, HOAs typically use one of the following three methods:
- Cash accounting
- Accrual accounting
- Modified accrual accounting