Underfunded reserves
What it means when the reserve fund falls short, and what the board actually does about it.
Underfunded reserves means the fund holds less than the reserve study says it should for the wear on the association's roofs, siding, and other major components. When a project can no longer wait, the board must choose among a special assessment, a reserve loan, or deferring the work, and a catch-up plan is how most boards avoid that choice.
What counts as underfunded
"Underfunded" is not a legal term. It describes where the reserve fund's actual balance sits against its fully funded balance, the amount the reserve study calculates should already be set aside for the deterioration on the association's components to date. Divide the actual balance by that figure and you get percent funded.
Industry convention treats the low end of that scale as a warning sign, not a legal violation.
"a high risk of special assessments and deferred maintenance"
Source: What Exactly is Percent Funded?, Association Reserves, Inc.
That description applies to associations under roughly 30 percent funded, according to the same practitioner source. No statute in this Course's research sets a required percent funded figure for reserves generally. Check your reserve study for your association's actual percent funded, and ask your preparer what band they consider safe.
What happens when the money runs short
When a project can no longer wait and the reserve fund cannot cover it, boards generally have three options: a special assessment, a reserve loan, or deferring the work. None of the three is free, and deferring is often the most expensive choice in the long run, because the underlying deterioration keeps running while the decision sits. A skipped sealcoat cycle can turn into a full repaving job; a skipped paint cycle can turn into siding replacement. Practitioners call this escalation "scope creep", a smaller repair growing into a larger replacement the longer it waits.
A special assessment is not the only fix, and it is rarely the first move. Boards facing a moderate shortfall usually raise ongoing contributions before they reach for a one-time bill.
The catch-up plan is the standard fix
For an association in the moderate, roughly 30 to 70 percent funded range, the standard response is a catch-up funding plan: raising reserve contributions over several years so the fund closes the gap gradually, instead of waiting for a shortfall to force a special assessment. This Course's research does not establish a specific number of years or a specific increase a catch-up plan should use; that figure is study-specific, and your preparer should be able to show the schedule for your association.
This is a fiduciary question, not just a budget one
A board's duty to plan for major repairs is part of its fiduciary duty of care. Courts generally protect a board's decision when it is made in good faith by a disinterested, reasonably informed board that could reasonably believe the decision served the association's interests, a protection often called the business judgment rule. That protection depends on the board being able to show it was informed and deliberate, not that it happened to guess right.
"could very well face a future legal challenge to that decision"
Source: Is Reserve Funding Mandatory?, Berding Weil
That is one law firm's assessment of a board that assesses below its own reserve study's funding recommendation with no documented reason. Deviating from the study is not automatically a problem; deviating without writing down why is what removes the paper trail that protection depends on. Whether a specific decision would survive a legal challenge depends on your state's law and the board's own record. Ask your association's attorney before assuming either way.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
The reserve fund holds less than half of what the roof replacement will cost. What can the board realistically choose from?
A reserve study finds the association at 45 percent funded, inside the moderate range. What is the standard next step?
The board approves an assessment below the reserve study's recommended funding level, with no discussion recorded in the minutes. What does that do to the board's legal exposure?
Sources
- What Exactly is Percent Funded?, Association Reserves, Inc.
- What Happens When Your HOA Reserve is Underfunded?, The HOA Handbook
- HOA Reserve Funds: Funding Levels, Studies and State Rules, ManageCasa
- Fiduciary Duties 101, Limiting the Liability of the Board, communityassociations.law
- Is Reserve Funding Mandatory?, Berding Weil
Related elsewhere in the Academy
Reserves
Not sure where your association's percent funded actually stands? Start with the reserve study line item before the next board meeting.
Whether your state requires a reserve study at all, how often, and whether the board may vote to underfund it varies by state and by your governing documents. Check your own state's statute and your CC&Rs before assuming any of this Course's general framing applies to your association.