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The HOALendingPro Talks About Borrowing

There comes a time when most communities simply run out of money before they run out of projects to complete. Or when an opportunity to purchase some neighboring land appears and the association just doesn’t have enough to pay for it. Or when a builder vacates a job leaving a community with a construction defect and no apparent way to pay for it. All is not lost. Take a deep breath and let’s talk about HOA lending and how the HOA Lending Pro can help you.

In the past two decades, I have seen communities large and small successfully realize their financial goals by borrowing money from an outside institution. While it is a relatively simple and straightforward process, it is not the kind of transaction that your friendly neighborhood bank is usually familiar with. Traditional loans are made to people or businesses, neither of which describes an organization whose sole purpose is to protect, maintain, and enhance commonly owned assets of a home owners association. From the viewpoint of the bank, lending to an HOA is more like lending to a municipality. And just like lending to a municipality, a lender wants to be assured the citizens of the municipality have the ability to collectively repay the loan.

Negotiating with a lender can be a tricky business. This HOA Lending Pro has seen it all over the years. I have seen HOAs with great looking business plans, well-kept minutes from their Board meetings, and solid financial records that would indicate they would be a great candidate for a loan. I have seen poorly laid out plans, accompanied by scraps of paper presented as records, and bank accounts that include bounced checks from associations that just couldn’t be helped. And I’ve seen everything in between, which is where most HOAs exist.

Perhaps the most important thing an HOA can do BEFORE applying for a loan is to take a good look at how much money will be needed and how likely the association is to be able to pay back the loan. There may also be considerations with the community’s governance and its ability to borrow money on behalf of the association. The bottom line is that a well-prepared loan application is often a harbinger of how successful the community will be in attaining the loan.

As the HOA Lending Pro, I can help your community prepare to borrow money or establish a line of credit. Contact me, Alan@HOALendingPro.com, and tell me your story. I may have helped lend more than a billion dollars to HOAs across the country but your HOA is the one I am most interested in helping now. Together, we will succeed.

Let me offer some negotiating suggestions:

1. Prepayment Penalty: Never allow for a prepayment penalty. This penalty is a concept evolved decades ago when fixed rate commercial lending developed in the banking industry. Banks have become far more sophisticated and are no longer dependent on such tools to maintain their profitability.

There are 2 common types of prepayment penalty. A penalty if there is a general prepayment (principal reduction). Or, a penalty if an existing loan is refinanced elsewhere. Such penalties may occur without being explicitly stated as such. Hidden penalties exist as “Yield Maintenance Fees” or within SWAP Rate Agreements. Always ask the lender: “What happens if the loan is repaid, in part or in full, either with regular or irregular principal reductions?”

Both penalty models can be costly to the association. Appreciate that the financial needs of the association change over time. The Association’s Board in place in the future may need to respond to needs of the community differently than the currently elected Board understands at the time of the financing. Having future flexibility is particularly important for the financial security of the Association.

The penalty concept that occurs only if the loan is refinanced at a different financial institution is potentially as costly as a General Prepayment Penalty. The terms of a future loan with the existing bank may not be as pricing favorable as other competitor banks at that time. Or, perhaps the existing financing provider may not be willing to extend additional credit in a fashion that is needed by the Association. By acquiescing to such a penalty structure, the Association has significantly limited its ability to obtain future financing at favorable terms.


2. Loan Fees: The lending market for community association loans is very large with many banking competitors operating locally and nationally. There is no reason to engage a broker to source such a loan. A simple internet search will yield a long list of direct lenders or utilize the services of “HOA Lending XChange” which is a market maker for such loans.

With the high level of competitiveness in this market, having Loan Origination Fees waived is not unusual. Negotiate aggressively! You are in the driver’s seat.

Service Fees: Never allow for fees having to do with any level of activity related to the loan that compensates the bank. The creative imagination of such fees by bankers is vast. Negotiate aggressively! You are in the driver’s seat. Typically, such fees occur with banks that do not have an extensive background in community association lending. However, for particularly complex projects. The bank may need to engage external professionals to define or monitor the proposed project. In such rare circumstances, service fees may be appropriate.


3. Deposit Accounts: Some banks require a deposit account relationship in order to lend. Other banks may not lend unless the Association is a pre-existing deposit customer. Both such banks are naïve. Negotiate aggressively! You are in the driver’s seat. Community Association loans are transactional in nature. Having a broad “banking relationship” is a1980’s concept with nominal current financial practicality for banks and none for the Association. Having a deposit account with a bank that is not your primary bank costs the Association money. There is additional effort (time & money) involved with accounting for such an account. The deposit account may not provide a competitive level of interest income.


4. Delinquency Levels: Some banks require that the Association’s delinquency level not exceed certain levels during the loan term. Although there is a degree of practicality for such a loan condition, the requirement cannot be allowed to trigger an “Event of Default”. Having such a condition in a loan document is particularly dangerous to the Association as it cannot control completely the delinquency level of unit owners during the full loan term as economic conditions fluctuate.


5. Events of Default: There is much more to a beneficial loan transaction than the interest rate. Banks fail. Bank management strategies change. Banking regulations change. The loan documents are the contract that govern the transaction for the entire loan term. If the documents provide an undo level of control to the Bank, the Association could be put in financially dangerously position if the bank’s operating environment changes. For example, a “Demand Clause” allows a bank to call the loan as due & payable in full within a short time frame without any particular reason. An “Insecurity Clause” allows for a bank to call the loan to be due & payable in full if it feels “Insecure”. An extremely broad concept!

The loan documents package needs to be considered entirely. Engage an attorney that has commercial lending background servicing borrowers. Have that counsel explain the ramifications of each clause. Once the documents are signed, the Association is exposed to whatever the documents allow.

 

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