HOA Reserves Rule of Thumb
Establishing and maintaining a reserve fund is the best practice for homeowners' associations. However, if you've never dealt with the subject before, it cannot be easy to understand your reserves. Therefore, it is beneficial to understand the HOA reserves rule of thumb regarding your reserve fund.
All About HOA Reserves Rule of Thumb
To understand what reserves are, you must first understand how a homeowners association works. A homeowner’s association is responsible for the upkeep of the community, with the primary goal of protecting property values. Without adequate funding, achieving such a feat is impossible. But where does an HOA's money come from? Every association is made up of members who are local homeowners. These homeowners pay monthly HOA dues, the majority of which go to the operating fund. The association uses this fund to cover day-to-day expenses such as landscaping, maintenance, and management fees. But what about unexpected costs? This is where the accounting for HOA reserve funds comes in.
What Are HOA Reserves?
A homeowners association's reserve fund is essentially a savings account. Whereas operating funds are used for routine expenses, homeowner’s association reserve funds are typically used for major repairs, replacements, and maintenance in the future, as well as unexpected costs.
What can you do with HOA reserve funds? HOA reserves can be used to cover a variety of major expenses in the future. HOAs, for example, can use their reserves for future roof replacements, pool resurfacing, street repaving, gym equipment replacements, and so on. While these costs can be reasonably anticipated, they occur so infrequently that it does not make sense to pay for them with operating funds.
Why Is the HOA Reserve Fund Important?
A reserve fund is essential for any homeowner’s association because it serves as a sort of safety net. When unanticipated expenses arise, you can use your reserves to cover the cost. However, when an HOA lacks reserves, you are usually left with two options. The first option is to impose a large increase in homeowner dues all at once. And we're not talking about a minor increase. To pay the expenses of a major expense, you will most likely need to increase dues significantly. A $10,000 replacement job, after all, isn't going to pay for itself. The alternative is to levy special assessments. Although the name is different from the first option, it achieves the same goal. Special assessments are one-time fees charged by an HOA to homeowners. In addition, in a few states, the number of special assessments that your HOA can levy is limited. The first and second options are not particularly popular among homeowners. When confronted with a significant increase in dues or a large special assessment, homeowners are likely to become enraged and file a lawsuit against the HOA. Furthermore, these options essentially punish current homeowners because previous HOA boards failed to plan reserve funds properly.
Is it mandatory for homeowners to contribute to the HOA reserve funds?
This is a common question among homeowners in HOA communities. Is it really necessary for homeowners to contribute to a reserve fund? The straightforward answer is yes. Homeowners in many HOAs are required to contribute to the reserve fund. Most associations calculate reserve fund contributions when preparing the annual budget and determining how much to charge in monthly dues. Homeowners are unlikely to notice a difference because the contributions are incorporated into the dues. HOA boards must present the budget to all members, which will include reserve fund contributions.
Understanding HOA Reserve Fund Requirements
You now understand what HOA reserves are, why they are important, and why homeowners must contribute. But what about the HOA reserves general rule for determining how much to keep in reserve? Is there a specific funding level that HOAs must adhere to?
It is not sufficient for an HOA to establish a reserve account. The HOA must also ensure that the reserve fund is kept at the appropriate funding level. When your HOA has a fully funded reserve account, it means that it can cover the cost of all major repairs and replacements. Unfortunately, the majority of associations have inadequately funded HOA reserves. This means that their reserves are less than 70% funded. The ideal HOA reserve funding percentage ranges between 70% and 100%. Of course, it is preferable to keep your reserves fully funded at all times. However, maintaining 70% funding is a commendable position. Underfunding of reserves will eventually result in special assessments or dues increases.