Ask the Mortgage Broker: Loan or Assessment for Condo Capital Repair?
March 12, 2013 — A reader writes: Our condominium is confronting several large repair projects. We are evenly divided between those who favor assessments to fund the individual projects as we do them and those who want to borrow enough money up front to pay for them all. Who's right?
This question concern the role of debt. Taking away our individual emotional and cultural concerns — some people abhor debt, others find ways to use it — the strictly financial approach compares the cost of the money being borrowed to the value or benefit derived from the loan.
A financial rule of thumb dictates that assets with relatively long lives should be financed with long-term debt. Therefore, a boiler or roof that might be expected to last 10 or 20 years theoretically should be purchased with 10- or 20-year debt. However, the circumstances of the individual borrower, as well as the current market conditions, might call for a modified solution.
Because a condominium, unlike a cooperative, does not have underlying mortgage debt, the issue of financing usually comes up in relation to capital improvements. For many years, condominiums funded virtually all repairs and capital improvements through unit-owner assessments because existing law did not allow them to borrow for that purpose. Even after the law changed in 1997, many condominiums shied away from loans and continued to levy assessments. Over time, though, more condo boards are deciding to borrow, especially for very large projects that would require onerous assessments.
Solidly Liquidating
Since condo loans tend to be motivated by specific projects, it is easier to match loan maturity to estimated asset life. The market does restrict this a bit since the longest loan maturity currently available is 15 years, with many lenders offering only 5- and 10-year loans. A further complication is that virtually all condo loans are self-liquidating, i.e., they must be paid off over the respective loan term (either 5, 10, or 15 years).
Nonetheless, paying for capital improvements through loans instead of assessments simplifies the funding process, spreads the financial burden of the capital improvement over a longer period of time and has significant tax advantages for many unit-owners.
Getting back to the question of assessment and loan, I will say neither choice is right or wrong for this condo board. However, I would argue that a loan is the better solution. Assessments are unpopular and, if repeated, can have a negative effect on unit values. They also can be troublesome to collect in a timely manner, which can delay the start or progress of needed work.
Loans, on the other hand, can be closed relatively quickly, have more useful tax advantages and provide a more equitable distribution of the financial burden than an assessment. That's because current unit-owners pay the entire assessment for an improvement that will last for 5, 10, 20, or more years. In contrast, a loan spreads the payment of interest and principal over that longer period and the changing unit-owner population.
To see how this question applies to cooperatives, read part two.
Patrick B. Niland, a mortgage broker, is the principal of First Funding of New York.
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