Finances

Is There Such a Thing as “Good Debt”?

The 1970’s Fram Oil Filter commercial used the phrase: “Pay me now or pay me later”. It was a vivid message that paying for quality preventive care is worth it. In the case of the ad, it was about the car’s oil filter. In a community association it is about the infrastructure and maintaining the common areas.  Association boards have the fiduciary responsibility to protect and enhance the property values of the community.  Boards focused on flat assessments, and deferring maintenance, will pay later in the form of: stagnant sales prices, and the risk of special assessments due to neglected maintenance.

When repairs and improvements must be made and Reserves are insufficient, then a loan can be a good option. Often, the loan will allow families to absorb special assessments through more modest monthly increases versus the challenge of a lump sum special assessment.

Projects that involve scaffolding and multiple buildings, when tackled all at once will cost less than phasing, too. Phased projects can result in contractors added costs exceeding the interest paid on a loan and phased projects can mean added repair costs while the buildings in later phases experience damages. This is especially true with projects that involve the building envelope.

PREPARING FOR A LOAN

All loans involve collateral or security, and the banker’s evaluation of the borrower’s ability to pay back the loan. The bank’s security (or collateral) with an association loan is the assessment income and the association’s right to collect assessments. Board members do not personally guarantee association loans.

The reports needed by the bank: Current Year Budget, Financial Statements for Current and Prior Year, Delinquency Report, Governing Documents, Tax Returns, and a Reserve Study are easily obtained by the property manager or board members. If the association doesn’t have a Reserve Study, each Lender will handle this differently. If there are any pending lawsuits with the association, disclose these right away.  The lender can navigate through those waters when there is open discussion of lawsuits.

FINANCIAL FOCUS

Each lender has guidelines used in evaluating the creditworthiness of the association, focused on:

  • Assessment Delinquencies:
    • Total number of units more than 60 days delinquent.
    • Total dollars more than 60 days past due.
    • Delinquency Reports that include present owners
      • Writing off Bad Debts is important to the fiscal health of the Association, regularly address these with the Accountant, Auditor and Legal Counsel.
    • Owner Reports:
      • All unit owners with their addresses making evident Occupied vs. Non-Owner Occupied units.
        • Discuss any seasonal variances in Owner Occupancy with the lender.
        • Identify owners of multiple units.
      • Income Available to Make the Loan Payment (or Debt Service Coverage):
        • How the association will make payments.
          • Income Sources: Assessments, Reserves, Special Assessment or all of these.

PRE-PAYMENT PENALTY LAND MINES

Thoroughly understand provisions for Pre-Payment penalties. For example: a 1% pre-payment penalty on the unpaid principal balance at the time of pre-payment is clear. A more punitive pre-payment penalty is known as Yield Maintenance. It is a prepayment penalty that allows the lender to recoup the interest they would have earned on the loan were it not pre-paid. Essentially, a Yield Maintenance pre-payment penalty provision means that the association as borrower does not benefit from pre-paying the loan at all.

Some lenders have provisions for no pre-payment penalty. Uncover these. Ask the lender if they will accept additional principal payments during the life of the loan and will the lender re-amortize the association’s payment. When the bank re-amortizes the association’s payment, their payment is reduced and matches the cash flow of the loan. This is a Win/Win for the association and homeowner.

WHAT’S IN A FEE:

Not all lenders charge the same fees: some are an additional source of bank income vs. a fee that covers costs.  An Origination Fee is usually a source of bank income. Closing costs however, are covering the cost of: preparing the loan documents, attorney review, filing fees and public record searches. Uncover these added costs.

HOW LONG WILL IT TAKE?

Involving a lender early is a best practice. Doing so will aide in promoting a full understanding of your Lender’s Loan Proposal and helps the communication with the overall community which takes time.  Clarity will improve the community sentiment about borrowing. The lender being involved early helps ensure planning and preparation for any budget impact. Questions to resolve with counsel are: is a unit owner vote needed, is a simple or super majority required, do the By-Laws allow the board to incur debt or is the loan addressing a life safety situation?

Seeking a lender that is a member of CAI is critical to understanding the complexity of your governing documents.   When all the requested reports and documentation are provided to the Bank, an initial Loan Proposal addressing your association’s borrowing capacity can be provided in a matter of days.  Otherwise, you may be working with a lender that is ill equipped for Association Lending.


By Kimberly Myles

Kim is an Educated Business Partner (EBP) member of WMCCAI representing WINTRUST Community Advantage Bank as vice president of business development for Maryland, Virginia, and Washington, D.C. delivering banking and lending solutions to community associations. Her experience in property management and decades of experience in finance, working both in lending and financial services technology, are vital to her success delivering solutions to property managers, and community associations’ board of directors. Kim serves as co-chair of the public outreach committee and is a member of 3 other committees at WMCCAI. She was recognized as the 2018 WMCCAI Volunteer of the Year.

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