Reserve Fund Meaning: A reserve fund is a special account designated for long-term repairs and replacement of commonly-owned property in a community association. Reserves are similar to a savings account in that it will only be used for its specific purpose.
For instance, reserve funds can be used to maintain the roof of a condominium building. Since all unit owners share ownership of the roof, everyone has to contribute to maintain, repair, or replace the roof. Every 20 years or so, roof shingles and other components will need to be replaced. Since this is a major expense, the condo association will set aside a specific amount of money each year to go towards repairing or replacing the roof.
How Much Reserve Funding Should You Have?
There are many factors that will determine how much reserve funding your association should have. Typically, when an HOA plans for their reserve fund, they call on trained experts known as Reserve Specialists.
They conduct a reserve study to examine every detail of the association’s assets and determine their lifespan and condition. They also include factors such as inflation to determine the cost of replacement at the end of an asset’s lifespan. Finally, the last step is to determine how much money the association needs to set aside each year.
Three Types of Reserve Funding
There are three basic plans for reserve funding: baseline, threshold, and full funding. These determine how prepared the HOA will be when the asset’s lifespan is up.
Fully Funded Reserves
Full funding offers the least amount of risk for homeowners. With this reserve funding option, the replacement item in question will be fully funded by the end of its lifespan.
With threshold funding, the association plans to have a certain limit, say 50%, of the item paid for by the end of its lifespan. The upside to this option is cheaper dues. Meanwhile, the downside is that it puts the owners at a greater risk. Owners may reach the end of the item’s lifespan without having the proper funds available to repair or replace it.
Baseline funding aims to keep the reserve fund above a $0 balance at the end of the item’s lifespan.
Determining Your Reserve in Accounting
Whichever path the association decides to take, the funds needed are figured in the HOA budget. A portion of the regular assessments paid by homeowners or unit owners goes towards the reserve fund.
Some states require associations to maintain a reserve fund by law. Most of the mortgage loans on condos are underwritten by the Federal Housing Administration. The FHA requires that a minimum of 10% of the association’s budget be designated for the reserves. If an association is not allocating at least 10% of its budget, it loses its FHA certification. This will almost always have negative consequences for the unit/home values.
Aside from that, who really wants to buy into an association that isn’t planning ahead? That isn’t executing good judgment and should be a red flag to potential buyers. Adequately maintaining a reserve fund will mean higher assessments over the course of time. However, this is much better than the alternative of a large special assessment.
Need Reserve Funding Assistance?
If your community association needs guidance when it comes to reserve funding, trust the financial experts at Clark Simson Miller. We’re not reserve specialists, but we have over 100 years of combined experience in the association management industry. We’ll be glad to schedule a consultation and assess your community’s overall financial health.