When homebuying, you’ll create a budget based on price, taxes and insurance. You’ll balance your budget against other expectations like home size, location and condition. You might find a home that’s part of a homeowners association (HOA) or condominium association (COA).

HOA and COA fees vary based on the services and amenities they provide. You’ll need to calculate the association fees required to live there. Association fees typically increase annually, so you’ll need to estimate those increases and plan accordingly.

Once you’ve got all that information, you’ll be ready. You’ll lock in the home’s price and build equity.

Not so fast.

If your association doesn’t manage its debts, you might end up with a bill you never anticipated.

Mismanaged HOAs and COAs can create budgetary snags

When your association doesn’t have enough savings to cover costs, they’ll look to the owners to fund their coffers using a special assessment. A special assessment is an additional fee charged to owners beyond regular dues. It usually covers unexpected expenses or major repairs.

In extreme cases, special assessments are so high that owners can’t afford to live there anymore. Consequently, they can lower the homes’ resale value.

To avoid this, evaluate an HOA’s or COA’s reserves before you buy.

What are reserves?

Reserves are the savings HOAs and COAs set aside for future repairs, replacements or unexpected costs related to common property areas. They’re meant to prepare for a rainy day and expected repairs. When an HOA or a COA has ample reserves, they can avoid special assessments.

How much your association has in reserves can also impact your home’s long-term value and the fees you pay to live there.

The purpose of reserves

The primary purpose of reserves is to prepare for significant planned expenses due to wear and tear and mechanical failures, including:

• Replacing the roof on the communal clubhouse
• Upgrading shared HVAC units
• Replacing walls, windows and siding
• Reinforcing building structures
• Repairing guest and service elevators
• Fixing shared pools and spas
• Repaving community walkways and roads
• Repairing community gyms, parks and outdoor recreation equipment

Here are two examples of reserves associations might use:

Regular reserves are budgeted annually. The association or a professional inspects the shared structures and mechanicals, estimating their lifespan. They also estimate the cost to repair them. The association includes the findings in its annual budget. It creates each year’s association fees using information like reserves and other budgetary items it oversees.

Catch-up reserves compensate for previous years when reserves were not collected or invested appropriately. They’re not for a specific project, but they fill a cash deficiency in the budget. Think of them like catch-up retirement savings that allow you to save more rapidly to catch up to where experts say you should be.

Methods of calculating and collecting reserves

HOAs and COAs use different methods to calculate and collect reserves based on anticipated needs. Here are two examples:

The component method, or component funding, evaluates each component individually to predict future maintenance and repair costs. Individual components include shared property, like pools, roofs, tennis courts, outdoor recreation areas, walkways, mechanicals, etc. This detailed analysis can result in a more thorough and higher reserve fund.

The pooling method collects a lump sum for potential repairs and maintenance during a specific period. Instead of allocating repair costs to line items or components, the pooling method estimates maintenance within a single building, like a high-rise. Amenities include indoor pools and spas, maintenance staff, door attendants, parking garages, laundry, guest suites, convenience shops, etc.

The more amenities and shared properties you have, the higher the assessments will be. Costs are higher to account for insurance, repairs and maintenance. Budgeting for the savings that reserves provide is part of that equation.

The role of inspections in formulating reserve budgets

Regular inspections of common areas and structural components are fundamental to establishing and managing a reserve budget. These inspections assess the condition of various elements like HVAC systems, roofs, common recreation facilities and elevators.

Typically, a professional reserve specialist or engineer conducts these inspections. They estimate repair and replacement schedules. They also estimate potential costs and suggest corresponding annual reserve fund contributions to meet the financial demand. Periodic inspections are critical in maintaining accurate, up-to-date reserve funds. They help avert the risk of underfunding and sudden financial demands on homeowners.

Participating in your association’s reserve planning and attending association meetings is another way to monitor where your funds are going.

Before you buy an HOA or COA property, review the reserves

Before purchasing a property in a HOA or COA, ask to see their reserve statement. This document details each common property item’s expected useful life, remaining life and estimated replacement cost. It also lists the funds available for these items and how much the association currently sets aside for them.

How do you know if there’s enough in the reserve funds?

If reserves are 100% funded, that’s good news. This means that the association’s cash in reserve matches the amount it needs to repair or replace known issues. Some experts consider 70% funded and below as underfunded reserves.

Ask your real estate attorney for help deciphering the reserve statement. Having your attorney review the association’s bylaws and covenants, conditions, and restrictions (CCRs) is a good idea, too. The extra document review fee they charge is worth it. Some states even require reserves and reserve assessments.

Think twice about HOAs and COAs with weak or sketchy accounting

No matter how much you love a place, if the association’s reserves, rules or management is questionable, walk away.

The reserve statement provides a window into the association’s financial stability and risk-planning abilities. For instance, an association with minimal reserves may be at risk of imposing special assessments. Ask questions if you see any red flags.

Stay involved even after you buy

Prices can change suddenly within a financially unstable HOA or COA. You won’t be able to depend on a fixed price as you can with a mortgage. When association mismanagement collides with catastrophes, those monthly fee increases can cost you.

As a member, you have meeting and voting rights. You also have the right to review financials and talk to the board. Stay involved and informed. It’s your investment!