Many HOA board members get into trouble due to not understanding the operating fund and reserve fund in a homeowners Association. If these two funds aren’t properly maintained, a Board can unintentionally cause the Association to fail financially. Therefore, it’s crucial that Boards understand how to correctly use the operating fund and reserve fund.
1. What is the Operating Fund used for?
The operating fund is the monthly or annual budget. It’s used for recurring expenses and services that involve the daily functions in the HOA, such as:
- General maintenance of common areas
- Property management
- Security services
- Insurance and taxes
- Utility expenses
- Office expenses
- Accounting and legal fees
When determining the operating budget, the Association's actual fees for one year will be a good indication of the next year's proposed budget. The goal of the operating budget is to keep expenses to a minimum and focus on necessary costs and actions.
2. What is the Reserve Fund used for?
The reserve fund is used for items that occur over a longer period of time and are generally large expenses, such as roof replacement, painting, maintaining streets, or unexpected projects.
A number of disclosures are required each year to determine how the reserves are being funded. The Davis-Stirling Act requires that the reserve fund is updated every year, and an actual on site reserve study done every 3 years.
A reserve study is best done by a reserve specialist. It's used to budget for future repairs and replacement expenses for common areas in an Association.
An update of the reserve fund procedures is required because there are often increases in things that the HOA doesn’t have control over, which may lead to an increase in HOA fees to keep the reserve fund at the right levels.
3. Where should an HOA keep their reserve funds?
The money for the operating fund and the money for the reserve fund should be kept in two separate accounts. The operating funds are typically kept in a checking account. The reserve funds are typically kept in a savings account, money market account, or even a CD. It often just depends on the homeowners association's current situation.
If your HOA has a large amount of reserve funds that it's saving for a large project, but that project won't be started for another five years, then you may get a better return on investment by putting that money in a CD where it will gain interest.
Your HOA reserve funds shouldn't be put into risky investments, such as Bitcoin, gold, or a cap stock in China. Ideally, you want your HOA reserve funds to be in a safe and secure location, where you are gaining some interest but not risking losing the homeowner's money.
Working with a trusted financial advisor or HOA management company that specializes in homeowners association finances can help you determine the best place to keep your reserve funds.
4. Where do the funds come from?
The money put into the operating and reserve funds come from HOA fees homeowners agree to pay when they move into the Association. These can be paid monthly, quarterly, or yearly, depending on the homeowners association governing documents.
The HOA board has the authority to raise the combined operating and reserve budget up to 20% above the previous budget. This gives the Board flexibility needed for unforeseen circumstances, such as compliance issues when a new law takes effect, damage done by a storm, or increases in operating costs.
5. Who oversees the funds?
The Board has the primary responsibility of overseeing both the operating and reserve budgets, and is required by law to review all financial information at least quarterly.
Since board members are volunteers and not necessarily experts when it comes to the nuances involved with HOA accounting, it's the Board's fiduciary duty to seek the help of experts. This may include an accountant, financial advisor, or HOA manager.
If the homeowners association is working with a management company, the entire Board and members have the confidence knowing how their money is being used in the Association and that it's being managed well.
6. How is an HOA board responsible?
The Board isn’t expected to be experts in everything, but is expected to ask the experts and make reasonable business decisions. It’s the Board’s responsibility to work alongside experts, such as accountants or a manager, and look to and understand the law, most importantly the Davis-Stirling Act.
A Board should consider sitting down with a management company to help them with the budget process and provide financial services. This will make sure things are done correctly and the Association will have a budget that reflects what it costs to run its community. Then, when an item becomes due, your HOA will have the money to pay for it.
7. How can HOA manager help?
An HOA manager can help direct and guide a Board through the legal and financial nuances required to keep the operating and reserve fund at the right levels. Not knowing the laws pertaining to the financial position of your Association does not release the Board from liability.
It’s important for HOA board members to sit down with a manager to go through the financial health of the Association. You don’t know what you don’t know. Even if you don’t have a manager, make an appointment/consultation with a trustworthy management company to ask questions, learn about services, and have an overview done of the Association’s financials.
Common services an HOA management company offers are:
- Budget preparation
- Actual vs. projected budget performance
- Receipt and distribution of funds
- Accounting Reports
- Prompt & accurate recording of assessment payments
- Monthly financial statements
Your HOA board may not be able to afford a full-time manager, or may not even need it, but it does need a wise financial plan put together with the help of a trustworthy expert.
The team of committed professionals at Hignell HOA Management can provide any accounting service you may need, and provide a customized plan to meet your individual Association's needs.