Why I am Opposed to An Association Mortgage

Last year, a board member suggested that the association consider taking a mortgage to meet certain reserve funding requirements. I think it's an appropriate time to look at this subject.

I am opposed to an association mortgage with one exception, and that is an emergency.  That is the only time I would consider an association mortgage to be a viable option. Perhaps management could suggest other circumstances, such as a huge liability. As we like to say, a lack of planning is NOT an emergency!  What would be an emergency? A tornado, earthquake or other natural disaster which does substantial damage to BLMH would be an emergency. (Note 2).

Why am I opposed, you might ask? Well, it's simply this. A $1,000,000 mortgage would cost our owners about $1,470,750. That means, each owner would pay about $24.32 a month for 180 months. However, the association would only get to use about $16.54 a month, because the difference, or nearly $8 collected from each owner per month, would go to the bank in payment of interest.

That's not a good use of unit owner money! A mortgage is a special assessment, in disguise. The unit owners would pay all current association fees and in addition, a fee equivalent to the mortgage payment. If we are each currently paying $295 per month, after acquiring the mortgage, the fee would increase to about $320 per month. Why? Because the association would still be required to build reserves for future repairs and replacement. If we borrowed $1,000,000 to do all driveways in 2011, the board would be required to levy fees to replace those driveways in 15-20 years, and of course, the roofs, the streets, and so on. A mortgage is not an escape! It assures higher fees unless we ignore future requirements and intend "special assessments forever" at our association.

Here's another way to look at this. If the association raised or increased fees by $24.32 per month per owner, rather than incurring a mortgage, and did its utmost to balance collections with expenses, and succeeded, this association would collect $1,470,750 in fees over a period of 15 years. That's the same amount as a mortgage occurring over the same 15 years. There is, however, a huge difference! That difference in funds available to the association would be $470,750 more! The association could repave HALF OF THE DRIVEWAYS with that. You didn't misread me. If this association decided to take a mortgage, it would hand the bank, as interest,  a sum equal to the cost of paving half of the driveways at BLMH!

Here's some numbers, to illustrate my point.

1. Amount of loan = $1,000,000
2. Years of mortgage = 15
3. Interest rate of mortgage = 5.5%
4. 180 total payments at $8,170.83
5. Closing costs, or PMI (Personal Mortgage Insurance) would be an additional fee.
6. Amount of mortgage, per owner = $4,377.23 (Note 1).

Click on this image to enlarge:

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Note 1.  This is an example ONLY. If the assessment per owner were based on their "per share" ownership of BLMH, some owners would pay more per month and others would pay less. Interest rates and fees would also be different than this example. A mortgage might be even more costly. If interest rates are higher the monthly assessment would be higher. Loan fees would reduce the amount of principal of the mortgage and possibly raise monthly assessments.

Note 2. I am opposed to an association mortgage with one exception, and that is for an emergency. For example, the occurrence of a violent act of nature, which severely damages buildings on the property. Insurance will cover some of the necessary repairs, but possibly not all. If the association lacks the necessary reserves for its portion, that would be a reasonable and justifiable alternative to a special assessment.

That is the only time I would consider an association mortgage to be a viable option.

Note 3. An association mortgage would punish savers. How is that? Here are the numbers. Using the example, a $1 million mortgage will require payments totaling $4,377.23 per unit owner. A $1 million assessment would require a payment of $2,985.08 per owner. The difference is the interest paid to the bank to repay the mortgage. An assessment to owners would cost less than a bank loan or mortgage. Of course, that doesn't include the effects of inflation on that $2,985.08; nor does it include the interest I would collect if I "saved" that $2,985.08.

Personally, I'd rather invest the difference of $4,377.23 - 2,985.08 in a tax free Roth IRA. At 5% annual appreciation, which is very doable appreciation, I'd have $2,894.19 for my personal use after 15 years. That's better than giving it this association so they can pass it to a bank as payment of interest on a mortgage. But that only makes sense, doesn't it!

Note 4. Our current treasurer has also stated, repeatedly, that he is opposed to special assessments and that includes a mortgage. Our treasurer and I are the only current board members who have straightforwardly stated such opposition.

Note 5. This note added the morning of October 10. No one has questioned one "flaw" in this post; I'm surprised. What is that flaw? I did not mention the reduction in purchasing power over the 15 year period of the mortgage. In other words, inflation can both work for us and against us. Here's the bottom line. If the association were to take out a $1 million mortgage, it would immediately have that $1 million to spend. However, if the association were to impose an assessment to raise that $1 million, it would collect those funds over a long period of time; 15 years in the example. The purchasing power of the dollar would erode over that 15 years. As a consequence, the value of goods and services the association could purchase with the $1 million gradually collected, would decrease over that 15 year period. Does that invalidate my position? No, it does not. What this means to an association is this; if a decision is made to impose an assessment for the purpose of raising a specific amount of funds, such as $1 million over a long period of time, that fee must also be raised, at the rate of inflation, to assure that the association has access to the full purchasing power of the funds. Sounds like jargon, but in fact, that is exactly what our association does. Our fees routinely increase and for three reasons. 1) to collect and save funds to replace aging infrastructure (that's called "building reserves); 2) to cover the cost of annual operations of the association (which is money spent immediately in the current year); 3) to collect a small additional amount each year, to compensate for both the increasing prices of that which will be purchased with the reserves some day in the future (5, 10 or more years distant) and erosion of the savings in the reserve fund "piggy bank." Of course, we may hope that the interest collected on the reserve savings will completely offset the inflation. However, that does not always occur.  The bottom line: I am opposed to a mortgage. I am fully engaged in planning and preparation.