HOA Reserve Funds: How Much Is Enough And How Boards Should Plan

The HOA reserve funds play an essential role in the long-term stability of an association’s finances. Without these funds, communities would have to resort to large special assessments or significant dues increases when a sizable expense comes up. Boards should plan accordingly to keep their association safe from unexpected costs.

What are HOA Reserve Funds?

The homeowners association reserve fund acts as a savings account for a community. It consists of funds that the HOA saves for the cost of future repairs and replacements of major components. It can also serve as a cushion for emergencies or unanticipated expenses.

Reserve funding comes from homeowners, who contribute a portion of their regular dues to a reserve account. The HOA board is responsible for calculating these dues and determining what percentage of them must go into the reserve fund.

Ideally, an association’s reserve account would be fully funded at any given time. This means that the HOA has 100% of the funding necessary to cover all anticipated costs according to the reserve study’s findings. Unfortunately, most communities have significantly underfunded reserves.

What is the Purpose of a Reserve Fund in an HOA?

The purpose of HOA reserves is to act as the first line of defense when major repairs or replacements become necessary. These costs tend to be higher than everyday maintenance expenses, and having a reserve fund allows the board to cover these costs without too big of a financial strain on homeowners.

Insufficient reserves can lead to consequences. If a roof breaks down, for example, the board would have no way of paying for the repairs or replacement. It would need to turn to owners and levy a large special assessment, typically payable in one go, just to avoid deferring the repairs.

Another option is to raise dues by a significant amount. While this can spread costs over more payments, it does not address the immediate situation. The HOA board would have to wait until it collects enough funding to pay for the repairs.

Some communities resort to taking out a loan when faced with insufficient reserves. This gives the board access to cash quickly, but it also places more of a financial burden on the community at large. Loans need to be repaid, often with high interest rates, and the funding would still have to come from homeowners.

What can HOA Reserve Funds be Used For?

Two things can determine what an association can use its reserve funds for: state laws and the governing documents. Board members should check their CC&Rs and bylaws for guidelines. Many communities are strict when it comes to how reserve funds can be allocated and spent.

That said, common uses for reserve funds include:

Repairs or replacements of roofs in common areas
Major improvements or upgrades
Renovation of an amenity or facility
Replacement of playground or gym equipment
Repainting of the clubhouse or other HOA-owned property
Repaving of private roads

Basically, reserve funds are used for the future major repairs and replacements of association-owned assets. Some communities will allow the board to dip into reserves for emergencies where insurance can’t cover the costs. It will all depend on the association’s governing documents.

Homeowners have a right to know the status of the association’s reserves. In Illinois, 765 ILCS 160/1-45 requires associations to furnish owners with a copy of the annual budget, complete with a summary of the reserves.

Can HOA Reserve Funds be Used for Operating Expenses?

Associations must keep the HOA reserve account separate from the operating account. This means board members can’t use the reserves to pay for operating expenses. Instead, the reserves are set aside for large-scale maintenance and repairs.

The operating fund pays for day-to-day expenses, which occur regularly throughout the year. Examples include regular maintenance costs, insurance premiums, security services, legal fees, office supplies, and management fees.

Many state laws and governing documents don’t allow associations to mix up the two accounts. Keeping them separate makes it easier to track expenses and maintain accountability.

What Qualifies as a Reserve Expense?

Whether or not something qualifies as a reserve expense will depend on state laws and the governing documents. That said, there are certain conditions that can determine if an expense counts as a reserve expense or not.

Common Property. If the component belongs to the association, and not individual owners, then its repair or replacement cost can be counted as a reserve expense. Examples include roofs, elevators, private roads, and shared building systems.
Limited Useful Life. An item that naturally deteriorates in both value and functionality can qualify as a reserve expense. These items usually need replacement after a certain number of years.
High Cost. Reserve items are typically expensive enough that the board can’t use the operating budget to pay for them because it would significantly strain finances.
Infrequent. Regular maintenance does not count as a reserve expense, but if the work does not happen every year and occurs on a longer cycle, then it counts.
Restores or Replaces. A reserve item is something that replaces or restores a component or facility. It is not something that only involves routine upkeep.

How Much Money Should be in a Reserve Fund?

The amount of money associations must have in their HOA reserve funds is not definite or universal. It will truly depend on the needs of the community and on the reserve study.

A reserve study takes into account the physical and financial assets of the association. From there, it determines how much remaining useful life each component has and how much it will cost to replace or repair them. This gives way to a funding plan, which dictates the amount of reserve contributions HOAs must set aside every year to meet its funding goal.

That said, the HOA reserves rule of thumb is to have at least 70% of the association’s funding goal at any given time. This ensures that the association has enough liquidity to cover repairs and replacements should they come early.

Generally, reserve studies must be performed every three to five years, but some bylaws require more frequent updates. Even without a statutory requirement to fund reserves or conduct a study, boards would be wise to maintain one anyway. Reserves keep the community in good physical and financial condition, so going without one can spell disaster in the long run.

Always a Good Move

The HOA reserve funds serve a crucial purpose in the grand scheme of operations. Board members should consistently maintain their association’s reserves or start now if they haven’t yet. While the operating budget is a fixture of finances, it can’t cover the cost of long-term repairs or replacements.

Forth Group provides HOA financial management services to communities in Chicago and the surrounding areas. Call us today at (312) 379-0400 or contact us online to get started!

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