Is Our Reserve Account Short?

By Kelly G. Richardson, Esq. CCAL, HOA Homefront Column 

Dear Kelly: Our reserves are very very low - can the city or state take over our association? B.P., Huntington Beach

Dear B.P: If the HOA’s reserve account balance is very low, meaning it is far less than the reserve study indicates should currently be accumulated to offset the existing level of deterioration of common area elements, the HOA is in financial danger. When a major common area element fails (decks, roofs, ?), the HOA will be unable to pay for replacement, leaving the members only two options: A major special assessment or a long-term bank loan (if the HOA qualifies for loans). Such an HOA may also violate FHA/FNMA lending requirements, which presently require that 10% of the HOA’s annual budget go to reserve accumulation. [Note- That figure will increase to 15% in 2027.] Condominium homeowners will have difficulty obtaining or refinancing mortgages if the association does not qualify for FHA and FNMA loans. If an HOA falls into complete disarray, it is unlikely that the city, county, or state would take it over. However, if someone petitions the court, a judge could order the HOA into a receivership. In receiverships, a third party takes over running the HOA for an expensive hourly fee. You don’t want that! Sincerely, Kelly

Mr. Richardson, I have enjoyed reading your articles for many years, and I have often shared them with our management and board. Recently, some directors have discussed using reserve funds to offset the operating budget and lowering our funded reserve level. The primary focus appears to be holding dues flat. This approach does not seem realistic or financially responsible. What would be the effect of reducing reserve levels? N.C., Mission Viejo 

Dear N.C.: Reserve funds are specifically accumulated to offset the ongoing deterioration of HOA common area assets. If the HOA takes those funds and repurposes them, that is considered “borrowing” from reserves under Civil Code Section 5515. That borrowing must be repaid within one year, per Civil Code 5515((d). Boards skimping on reserve savings to artificially keep assessments low are not being truthful to their neighbor homeowners – because they are obscuring the fact that the HOA will not be ready for major replacement expenses. Thanks, Kelly

Kelly: What power does a board of directors have to implement a financial plan for the funding of the reserve account without approval of all the homeowners? B.W., Solana Beach. 

Dear B.W.: Budgeting, including complying with reserve study accumulation requirements, is one of the board’s basic responsibilities. For HOAs without properly funded reserve accounts, Civil Code 5550(b)(5) requires the HOA to have a funding plan to catch the HOA up on its reserve accumulation needs. The HOA’s shortfall on reserve accumulation funding must also be disclosed annually to members under Civil Code Section 5570 and 5300(b)(3). It is a board responsibility because it is too complicated to submit to a vote of the entire membership.

HOAs that do not set aside sufficient money to offset deterioration of HOA-maintained common area components are quietly falling into unliquidated debt. Such a debt becomes liquidated when the component must be replaced and the “bill comes due.” Unfortunately, unwise HOAs will not have the funds ready for that expense if they shortsightedly only focused on month-to-month expenses. Best, Kelly