Whether you’re an investor interested in buying a home in a Homeowner’s Association (HOA), or you’re the HOA trying to budget in advance for major repairs or replacements of things like roofs, siding, roadway, etc., you’ll want to understand better the answer to the question, “What is Percent Funded?”
Homeowner associations (HOAs) typically have two types of monetary accounts:
- Operating Fund
- Reserve Fund
The operating fund holds the money that is used to do just that – operate the day-to-day expenses, maintenance, and association fees. This is where most of the transactions take place.
The reserve fund is more for those larger expenses that don’t occur so frequently, when you need to make repairs or replace major assets.
A common mistake that HOAs make is to underfund the reserve fund. Then, when costly repairs or replacements are needed in the future, they struggle to get them done. The best way any HOA can be prepared for future repairs or replacements is to adequately fund their reserves. But the question remains what is adequate and how do you determine the adequacy of an association reserve account. The short answer is by looking at an association’s Percent Funded Level.
What Is Percent Funded HOA?
As defined by the Community Association Institutes’ National Reserve Study Standards , Percent Funded is “the ratio, at a particular point of time, of the actual (or projected) Reserve Balance to the Fully Funded Balance, expressed as a percentage.” To put it simply, Percent Funded is a measure of the depreciated value of the association’s common area assets against how much it has in the bank (reserve fund).
HOA Percent Funded: How To Calculate
Percent Funded is the ratio that an association can use to determine just how much to fund the HOA Reserve Fund. Essentially, the ratio is:
Percent Funded = Current Balance of Reserve Fund / Fully Funded Balance (Reserve Needs)
Ideally, HOA Percent Funded should be 100 percent, meaning Current Balance should equal the Fully Funded Balance. It is however unfortunately quite common for association’s to have percentages that are much lower.
How To Compute Projected Reserve Fund
To determine the Projected Reserve Fund, estimate the association’s deterioration value of the larger assets, such as roofs, siding, pool, roadway, etc. Then, multiply the fractional age of each asset by the cost it will take to replace or repair it (Replacement Cost) and then add them all together.
Let’s look at a simplified example:
ABC HOA has $1,000 in a Reserve Fund Account.
ABC HOA has a pool that was put in 5 years ago, is estimated to last 10 years, with the cost to replace it coming in at $10K. To reach it’s target and equally distribute the cost amongst its members, the association should be raising approximately $1K every year toward the $10K replacement cost. Because the pool has used up 5 years out of 10, you calculate this as 5/10ths of the $10K replacement cost, which equals $5K. The Fully Funded Balance or amount that the Association theoretically should have saved by now is $5,000.
To calculate the Percent Funded Level you need to take the $1K Reserve Fund Account Balance and divide it by the Fully Funded Balance of $5,000 which equals 20% funded. If the association had $5,000 in its Reserve Fund it would be 100% funded.
Hopefully, you now understand better the answer to the question, “What is Percent Funded” when it comes to HOAs.
HOAs should aim for at least 60% Funded to help tackle major asset repairs or replacements down the road. Those that fall below 60% are at greater risk of not having the funds they need when major expenses arise and will have a greater need to supplement their funding with additional measure such as Special Assessments.
Know the health of your Association and look to the Percent Funded Level to understand how well prepared your Association is to address anticipated costs in the future.