Operating Funds vs Reserve Funds: Understanding Your HOA Fees

Nobody enjoys paying fees. That’s just human nature. But it’s a lot less painful when you know where your fees are going, what they pay for, and how you benefit from their use.

HOA funds are a perfect example. We may grumble when they’re due, but it helps when we know how they are used to benefit our community. Your homeowners’ association board has a lot of financial responsibilities, and one of them is deciding how much money goes into HOA operating funds and how much goes into HOA reserve funds.

If you’ve heard the terms before but without any context, they’re probably a little confusing. To put it in a home accounting perspective, imagine your HOA’s operating funds to be like your checking account. The reserve funds are like a savings account.

Of course, when those accounts are filled with other people’s money, they take on some different characteristics. We’re going to take a look at these two different funds and how each is managed to most effectively use your HOA fees.

HOA Operating Fund

Like your checking account, money kept in an HOA operating fund is used for regular, ongoing expenses. These are the expenses your HOA board expects, the day-to-day operating funds of the HOA.

Operating funds cover ongoing services like landscaping, general maintenance of common areas, security, and housekeeping. Your HOA may have all of these or none.

Operating funds also cover expenses like taxes and insurance. Your HOA dues are worth every penny just to avoid burdening a community member with preparing those taxes or doing the HOA accounting. Anyone who has ever been an overburdened board treasurer will agree.

The cost of the accountants and lawyers your HOA hires to take care of those headaches comes from operating funds.

Depending on the nature of your HOA there might also be utilities to pay, including gas, electric, water, and sewer. Smaller items are paid using these funds, like postage and office supplies.

If your HOA has any employees, their salaries come from the operating funds.

These expenses are predictable and ongoing, even if they aren’t scheduled services. They are very much like the bills you pay to keep your household running. Your HOA board budgets for them based on previous costs and any anticipated increases.

HOA Reserve Fund

Reserve funds are for big projects that don’t recur regularly. Sometimes the projects are planned, other times they are not. Reserve funds are like a combination of a savings account and a rainy day fund.

Planned projects may include major landscaping projects or putting in a new playground. Some HOAs are responsible for road and sidewalk maintenance. Others may decide to build a new gym or add a pool to the community.

Other large projects that get planned in advance and are paid for using reserve funds are big repair projects. Roof replacement on common buildings, fence repair or replacement, painting of buildings in common areas, and other infrequent maintenance comes out of reserve funds.

Those planned projects sometimes end up taking a back seat to unplanned projects, such as major repairs. If a storm tears off the roof of a common building, your HOA probably doesn’t want to wait for an insurance check before initiating clean-up and repair.

That means that reserve funds need to be liquid and available. It may be tempting to invest those funds as your HOA plans for large projects, but it’s far wiser to expect the unexpected.

The Role of the HOA Board

Your HOA board is responsible for deciding which expenses come from the operating fund and which come from the reserve fund. They are also responsible for keeping the funds separate and keeping the books for each in proper order.

It isn’t always easy to decide if an expense should come from the operating fund or the reserve fund. The examples above are pretty cut and dried, but there is significant grey area.

Small repairs may end up being expensed against operating funds. A broken sprinkler or window could be affordable enough to fix that it wouldn’t strain the operating fund.

On the other hand, sometimes a service that is normally expensed against the operating fund is transferred to the reserve fund. The best example here is landscaping. An HOA may hire its regular landscaping service to do additional work.

While the company’s regular services are expensed against the operating fund, an additional large project may use the reserve fund. Normally, these larger projects are not expected to recur. They may, however, add additional expenses to the regular landscaping budget.

Ultimately, the responsibility of allocating funds in the best interest of the community lies with the HOA board. Making sure that there is enough money in the reserve fund for the landscaping project and the operating funds to maintain that project is part of their job.

A reserve study conducted every few years by an outside professional helps your HOA plan allocations to the reserve fund. The most financially stable HOAs are those that have 70-100% of the suggested reserve funds available. The reserve study is another tool for the board to use when allocating funds.

The hazards of underestimating reserve fund needs are significant. A large repair may cause an HOA to impose a special assessment on homeowners, which is a fee on top of the regular HOA fees to cover the cost of the unbudgeted expense. An unexpected special assessment is guaranteed to be stressful and unpopular.

While even a well-run HOA may encounter the need for a special assessment, it is far less likely if the board has all its accounting ducks in a row.

Laws and regulations governing the financial responsibilities of homeowners’ associations vary from place to place. HOA accounting is not one-size-fits-all. HOA finances can be complicated and this responsibility is large.

If your HOA does not have a professional bookkeeping service or is not getting regular reserve studies, it’s at risk of costly mistakes. If you aren’t on the board of your HOA, ask if they are getting the professional advice they need. Don’t hesitate to talk with us at Homey to learn more about ways our financial planning solutions are helping HOA board’s to reduce those costly mistakes and make better financial decisions for their homeowners.