Buying a home within a homeowners association (HOA) or condominium community often involves more than just regular monthly dues. Occasionally, the HOA may levy a “special assessment,” which is a one-time fee charged to homeowners to cover unexpected or large expenses, such as major repairs or legal settlements that exceed the budget covered by regular dues.
When purchasing a property with a pending or upcoming special assessment, mortgage lenders commonly require a special assessment escrow. This escrow account ensures funds are set aside to pay the assessment promptly, protecting the lender’s security interest in the property.
How Does a Special Assessment Escrow Work?
Think of this escrow as a temporary savings account managed by your lender. Instead of paying the special assessment fee in a lump sum yourself upon bill issue, your lender collects the required amount—often at closing or through increased monthly payments—to hold and disburse directly to the HOA when due.
The process generally includes:
- Identification: During loan underwriting, lenders review HOA documents, including a “condo questionnaire,” identifying any upcoming special assessments.
- Escrow Condition: If the special assessment is significant, the lender imposes a funding requirement for an escrow account to cover it.
- Funding: Borrowers typically fund the escrow at closing with a lump sum corresponding to their share of the assessment. Occasionally, lenders may allow prorated monthly payments into escrow.
- Payment: The lender disburses payment from the escrow account to the HOA by the assessment deadline, preventing liens on the property.
Once paid, this escrow account is closed, distinguishing it as a temporary measure unlike regular escrow accounts.
Why Do Lenders Require This Escrow?
The primary reason lenders impose this requirement is risk mitigation. Unpaid special assessments can lead to HOA liens, which in many states act as “super liens” that take precedence over the mortgage. This means the HOA could be paid before the lender if the property faces foreclosure.
To protect their investment, lenders require assurance that special assessments will be paid timely. According to Fannie Mae’s Selling Guide (B4-2.1-03), lenders must verify proper handling of special assessments to maintain project eligibility.
Special Assessment Escrow vs. Regular Escrow
| Feature | Regular Escrow | Special Assessment Escrow |
|---|---|---|
| Purpose | Covers predictable recurring expenses like property taxes and insurance | Covers one-time, significant HOA or condo fees |
| Duration | Ongoing for life of the loan | Temporary, until assessment is paid |
| Funding | Paid monthly as part of mortgage payment | Usually lump sum at closing |
What Should Homebuyers Do?
Facing a special assessment escrow requirement can mean unexpected costs at closing. Options include:
- Negotiating with the seller for a credit or payment assistance
- Discussing payment options with your lender
- Considering whether to continue with the purchase if finances are tight
Additional Notes
- Special assessment fees are generally not tax-deductible (IRS Publication 530) but paid amounts can increase your home’s cost basis, potentially lowering capital gains tax upon sale.
- If an assessment plan is canceled after funding escrow, lenders typically refund the amount.
- Frequent or large special assessments might indicate an HOA with financial challenges.
For more details on managing HOAs and lien risks, see our HOA and Condo Liens article. To learn about escrow account handling, refer to our Escrow Account Mismanagement in Liens post.
References:
- Fannie Mae Selling Guide B4-2.1-03: https://selling-guide.fanniemae.com/Selling-Guide/B4-2-Condo-Co-op-and-PUD-Project-Eligibility/B4-2.1-General-Project-Eligibility/B4-2.1-03-Project-Eligibility/1032997781/B4-2-1-03-Project-Eligibility.htm
- IRS Publication 530: https://www.irs.gov/publications/p530
- Investopedia Special Assessment: https://www.investopedia.com/terms/s/special-assessment.asp
By understanding the special assessment escrow requirement, homebuyers can better prepare for closing costs and protect their investment in HOA or condo properties.