For many condominium association Boards of Directors, it’s budget season as the members work to produce a budget for the start of the new fiscal year in January. This is why we wanted to send out a quick reminder about the importance of funding the replacement reserve account.
The agencies (FHA, Fannie Mae and Freddie Mac) require that a condominium association contribute a portion of its annual budget to the reserve account. Most commonly, this portion is 10%. In addition, the agencies do not like when the balance of the reserve account dips below 10% of the annual budget.
Here are some common questions that we hear:
- Does the reserve contribution have to be shown on the budget? Yes. This contribution must be shown as a line item on the budget. It cannot be displayed as being whatever is left over at the end of the year.
- Must we make periodic payments to the reserve account? Yes and no. While it is better to make payments in this manner to show that the HOA is purposefully moving money to reserves, none of the agencies ask for a month-to-month breakdown unless there is a question about reserve funding.
- Can we use reserve funds during the fiscal year? Yes, you may use reserve funds for capital projects or emergencies; that’s what they are there for. However, reserve funds must never be used to pay operating expenses.
- If we use reserve funds, do we have to contribute a net 10% to the reserve account? Not necessarily – this area is subjective, especially when applying for an FHA condo approval. If it is clearly shown that any reserve withdrawals were used for capital projects, the HOA should be ok so long as the withdrawals weren’t “excessive”.
- Can we contribute less than 10% to the reserve account? Not unless the HOA has a reserve study that states that it can. While the 10% figure is fairly arbitrary, the agencies stick by it.
- How much should we have in our reserve account? This area is also subjective when it comes to FHA. The agencies don’t want to see a balance of less than 10% of the annual budget. However, just having this amount may not be enough if the association is older and it is expected that capital projects are upcoming. [This is a whole other topic of discussion.]
Also please remember that the agencies don’t like to see a loss posted on the income and expense statement. Some accountants will recommend showing a loss to avoid an income tax liability but showing a loss could result in delays, especially if the HOA is applying for an FHA condo approval.
If you have any questions about the budgeting of reserves or how an agency will view your budget, please feel free to ask us questions. As consultants, we have assisted dozens of HOAs and property managers to create budgets that will appease the agencies.
You may contact Eric Boucher directly at 404-433-4565 or at email@example.com. You may also visit our social media links for more information about related topics or just to connect with us.
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