Funding the Condominium Reserve Fund with a Loan

L.G. from New Jersey writes:

Dear Mister Condo,

I live in a mid-century, 7-story building that was converted from an apartment building. We lost part of our roof from Super Storm Sandy. We are applying for a SBA loan at 3% to pay for the repairs.  My thought was we were paying most of the repairs with our Reserve Funds and using the loan to pay for anything above that, but now I found out that our reserves covered most of those repairs and the loan will be used to re-fund our reserves.

To me that seems rather silly to pay 3% on a loan to fill our 1% interest bearing account. It seems to me that using these funds for a major repair is using the fund for the purpose it is intended.  Some board members on the other hand believe that if we don’t have a fully funded reserve it will be harder for buyers to get a mortgage.  This is a $300,000.00 loan we’re seeking with the expectation that we will only need about $200,000.00.  I believe we had about $180,000.00 in reserves prior to this repair.  I could see if we wanted to ensure we had $20,000.00 – $30,000.00 left in it and use the loan for anything above that.

I’m confused in the need for a reserve and the fear that if we use our reserve for an emergency as is its purpose, that we will then be “punished” for doing so. Also, we talked at one time about getting FHA approval for our building but the Board is afraid it will attract people with not enough money to make their payments.  I think it lets people keep more money in the bank. Some have advised me that if we get the approval our values will increase. Do you have any thoughts on the positive and negative of FHA approval? Thanks in advance for your insight and clarification.

Mister Condo replies:

L.G., I am sorry for the loss to your community caused by Super Storm Sandy. I am glad to see that the only damage you are reporting is financial in the form of a roof. As you know, so many residents here in the Northeast lost so much more. That being said, let’s talk about Reserve Funds and their proper use.

Every state has their own laws and rules about condominium and common interest property. I am neither a lawyer nor an expert in New Jersey’s laws for such properties but suffice it to say a Reserve Fund is a very important financial tool for condominiums. Whether by law or just good fiscal policy, the Reserve Fund should stay intact as it protects the community’s common elements for years to come. More importantly, whether you seek FHA approval or not, outside parties like banks and lending institutions look at the Reserve Fund to determine potential liability to mortgage holders within the community. An underfunded Reserve may trigger a decrease in banks willing to lend to potential buyers or refinance existing owners. That would create a truly catastrophic situation for your community. FHA approval is another topic altogether although not unrelated. Achieving and maintaining FHA approval is a good idea because so many of today’s mortgages are offered by FHA-backed lenders. Holding FHA approval can streamline the mortgage and refinancing opportunities for new and existing unit owners. It can be argued that it also opens the community up to potential buyers who may not be as fiscally strong as the Board would ideally like but I think that reasoning is shortsighted and may even open the Board up to potential lawsuits by current and/or future owners who cannot obtain a mortgage from an FHA-backed lender. I think your Board would be wise to investigate their options and talk to an FHA certification specialist. In your state, I would turn to the New Jersey chapter of the Community Associations Institute to inquire about FHA certification specialists. You can find them at http://www.cainj.org/.

While taking a loan at 3% to pay back a 1% interest bearing Reserve Fund may not make common sense, it does make perfectly good business sense. I think your Board is exercising very good long-term thinking in this approach and that small amount of interest is simply a cost of doing business. The good news is that your community will get its new roof and your fiscal health will be preserved. Best wishes!