Just like any other organization, homeowners associations can also suffer from bad debt. But, what exactly does HOA bad debt look like? And would exposing the association’s debtors solve its problems?
What Is HOA Bad Debt?
In business, bad debt is a monetary amount that a debtor owes a creditor. It is deemed a “bad” debt because it is unlikely that the amount will be paid. Thus, another name for bad debt is an uncollectible account. For homeowners associations, the definition remains largely the same. In this case, the creditor is the HOA and the debtor is the homeowner.
Homeowners associations oversee the maintenance of communities. It is common for an HOA to pay vendors for various services, including landscaping, cleaning, repairs, and the like. To pay for these expenses, the HOA collects regular dues from its members or homeowners.
The HOA board determines how much each homeowner has to pay in dues by first preparing an annual budget. This budget will consist of anticipated costs for the upcoming year. From there, the board divides the total amount (plus reserve contributions) among all of the owners in the community. Members will typically pay their dues on an annual or monthly basis.
When homeowners fail to pay their dues, their account becomes delinquent. Over time, as these delinquent dues pile up, they become bad debts. HOA bad debt can significantly impact the association’s finances. When too many owners owe the association money, it sets a bad precedent and may also cause a domino effect on all other operations.
Can You Publish the Names of Delinquent Homeowners?
There are a number of ways to collect unpaid dues. Most homeowners associations have the ability to place a lien on the property of the delinquent owner. They can then subsequently choose to foreclose on the property. Other associations refer bad accounts to third-party collection agencies.
While it is important to have HOA debtors settle their outstanding balance, an association should not resort to publishing the names of delinquent homeowners. Some HOA boards may consider taking this route in an attempt to humiliate the delinquent owners into paying their dues. But, divulging the names of bad debtors does more than just that — it can expose the HOA to liability as well.
Under the federal Fair Debt Collection Practices Act, publishing the names of bad debtors could be interpreted as blacklisting. Of course, not all courts will consider homeowners associations as debt collectors, but there are some states that do.
Furthermore, it can be viewed as a breach of privacy. There are some records that homeowners can gain access to without qualms, such as the association’s budget and income statement. In terms of financial records involving delinquent owners, though, that is another matter entirely. In many states, an HOA will encounter legal trouble if it reveals the names of delinquent members.
Even in states where it is permissible to disclose delinquent owners, it is still generally not something associations should do. Instead of listing the names of delinquent owners, it is more advisable to list them down according to the account or unit number. In doing so, the association can protect itself and the identity of the bad debtor.
The Importance of Accounting for HOA Bad Debt Line Items
While some may have other revenue streams such as rental income, a majority of homeowners associations rely on member dues as a primary source of income.
When this stream runs dry, an association would have nothing to fund its operations. Common areas would go unmaintained, and damage will inevitably occur. Projects would have to come to a screeching halt, too. Soon enough, the neighborhood’s curb appeal will go down along with property values.
There are other detrimental effects of bad debt, too. When the association’s operating fund fails to cover all of its expenses, the board may be forced to dip into its reserves. An HOA’s reserve fund is important in that it is money set aside for future major repairs and replacements. When an association’s reserves become underfunded, there may not be enough money to pay for the cost of repairs and replacements when the time comes. The board would then need to increase dues by a huge margin in order to make up for the deficit.
Special assessments can be another consequence of failing to account for bad debt. Without sufficient funds, the board would need to levy special assessments against all owners. This not only creates another financial obligation for owners, which will likely not go over well with them.
What to Remember When HOA Budgeting for Bad Debt
By now, it is clear that every homeowners association needs to include a bad debt line item in their annual budget. But, how exactly should your HOA board account for bad debt? Here are a few tips.
1. Track Your Delinquencies
You can’t account for your HOA bad debt expense if you don’t know how much bad debt you have. To start, make sure to track your delinquencies with the help of a spreadsheet. For each account, input the amount owed according to how long it has been owed. Each amount will move to the next column (example: from 60 days overdue to 90 days overdue) as it ages.
Typically, you will need to have four columns divided into 30-day increments, as follows:
- 1-30 days overdue
- 31-60 days overdue
- 61 to 90 days overdue
- More than120 days overdue
Make sure to update your tracker on a regular basis. As time passes, you will be able to pinpoint trends and come up with a solution. As debt moves along from one column to another, it becomes more unlikely to be paid. Even when tracking delinquencies, it is best to use account or unit numbers instead of the names of owners.
2. Add a Cushion
If you know you have bad debt to account for, your board will need to add a cushion to your budget. This is so you won’t run out of money before the association can fully pay for all related expenses. Aside from existing bad debt, you may also want to pad your budget a bit more to account for future problems with collection.
3. Adjust Other Expenses
A good rule of thumb is to only have 1-2 percent uncollectible accounts. But, external factors can also influence this percentage. For instance, in a down economy, you might increase that to something more realistic as owners encounter financial strife.
Otherwise, if you have a high delinquency rate, you might need to take action to resolve the matter. You may need to hire a collection agency or place a lien and initiate foreclosure proceedings. This would mean having to increase your budget for related expenses such as collection agency fees, legal fees, and court costs.
4. Check With Your CPA and Attorney
Unless your HOA board is lucky enough to have an expert, it is best to seek counsel from a Certified Public Accountant as well as an attorney. A CPA will be able to tell you how to budget for bad debt and how much is deemed uncollectible. An attorney may offer insight on the possible actions you can take to get your bad debt down to a more manageable percentage.
Stick to Good Practices
HOA bad debt is not something you should take lightly. Although reducing your delinquencies should definitely come as a priority, it should not involve disclosing the names of those who owe the association money. Apart from being unlawful in many places, this type of practice will only show contempt between your board and the community’s residents.
Are you looking for an HOA management company to help you with dues collection? Clark Simson Miller is your best option. Call us today at 865.315.7505 or contact us online to learn more about our services.
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