HOA Loan Interest Rate Explained: Why the Fed Rate Doesn't Matter as Much as You Think

Suppose your HOA board is sitting around the table talking about that new roof the community desperately needs. The facility may require maintenance work which includes either repaving the parking area or performing exterior building repairs and conducting essential structural maintenance. The project will need substantial financial support which requires you to secure a loan.

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The discussion moves to current Federal Reserve interest rates. It sounds like a smart move. After all, we hear about the Federal Reserve and interest rates on the news all the time. However, the Federal Reserve's interest rate adjustments do not affect your HOA loan interest rate to the extent which you might believe.

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Most HOA loans are long-term loans with fixed rates. And those rates aren't based on what the Federal Reserve does with short-term rates. Instead, they're based on something completely different: the 10-Year U.S. Treasury Bond yield.

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Your Homeowner’s Association needs to understand this difference because it will help you avoid spending thousands of dollars unnecessarily, pick better loan deals, and figure out when to borrow money correctly.

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The Two Rates Everyone Confuses

To make smart decisions about HOA financing, you need to understand the difference between two important interest rates. Most people confuse these terms because they operate through separate mechanisms which impact different loan categories.

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The Federal Funds Rate (What You Hear About on the News)

This is the rate that shows up in headlines all the time. The Federal Reserve Board maintains control over this interest rate which news reporters actively discuss throughout their broadcasts.

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The following information describes the subject.

• Banks use their reserve funds to make overnight loans to each other through this rate.
• The Federal Reserve employs short-term interest rates as its economic management instrument which it controls through rate modifications.

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What it affects:

• Credit card interest rates
• Adjustable-rate mortgages (ARMs)
• The Prime Rate (what banks charge their best customers)
• Other short-term borrowing costs

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The Federal Reserve increases interest rates which lead to immediate cost increases for all short-term loan operations. The established interest rate served as a tool to determine short-term loan costs, but it did not establish any connection to long-term loan pricing. The system operates as a short-term financing solution which supports both overnight and brief duration borrowing needs but does not support extended loan periods of five to ten years.

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The 10-Year U.S. Treasury Yield (What Actually Matters for Your HOA)

This is the rate your board should be watching—but most boards have never heard of it.

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The following information describes the subject.

• The interest rate (or yield) that investors demand when they lend money to the U.S. government for 10 years
• The standard benchmark for all long-term, fixed-rate lending in America

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Why it matters for HOA loan rates:

• The lending industry bases all mortgage and term loan and HOA loan decisions on this value.
• The yield from U.S. Treasury debt serves as the base interest rate for long-term debt because it represents the risk-free borrowing cost.
• When this yield goes up, HOA loan interest rates go up
• When this yield goes down, HOA loan interest rates go down

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The 10-Year Treasury yield functions as the beginning point for this research. Your actual HOA loan rate gets built on top of that foundation.

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Why Long-Term Loans Don't Use Short-Term Rates

The main reason your HOA loan interest rate differs from the Federal Reserve overnight rate stems from the fact that time plays a crucial role in determining risk levels.

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A lender who provides your association with funding for 5 to 10 years duration makes an extended financial pledge. They need to know they'll get paid back with enough interest to make up for all the things that could happen during those years.

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What could change over 5-10 years:

• Inflation could go up or down
• The economy could grow or shrink
• Interest rates in general could move a lot

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The Federal Reserve maintains its power to adjust interest rates as whenever they see fit.

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A lender cannot establish a 10-year loan period which follows the constantly shifting overnight interest rate. The process would require predicting weather conditions for the following ten years through current weather pattern evaluation. It just doesn't work.

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The 10-Year Treasury yield is different. The current model contains investor predictions about future economic performance, inflation rates, and interest rate movements during the upcoming ten years. 

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The lending industry depends on this system for its operations. It reflects the long view, not just what's happening right now. The method enables both parties to establish an interest rate which they can use for loans that need to be repaid over an extended period.

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How Your HOA Loan Interest Rate Is Actually Set

Most long-term HOA loan rates follow a straightforward formula. Once you understand it, loan quotes will make a lot more sense.

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The Formula: HOA Loan Rate = 10-Year Treasury Yield + Lender Spread

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There are two parts to this formula:

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The 10-Year Treasury Yield (The Moving Part)

This is the variable part of your rate. It changes every single day based on what's happening in the bond market.

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What makes it move:

• Inflation expectations
• Economic news and data
• Global events that affect investor confidence
• What investors predict the Federal Reserve will perform in upcoming periods.

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The number exists beyond your control, but you should monitor its progress. The optimal time to obtain a loan emerges when interest rates are low. The project might need to wait if rates are high.

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The Lender Spread (The Custom Part)

This is the additional interest the lender adds on top of the Treasury yield. The HOA process varies between organizations because they create individualized solutions which match the needs of their members.

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What affects your lender spread:

• The lender needs to pay operational costs while his business needs to generate profits.
• The financial state of your organization decides whether it can keep reserve funds in place and service the debt. Do you keep track of completing all your assignments before their corresponding due dates? Are your finances well-managed?
• The lender evaluates credit risk through assessment of three main factors which include community size and age and financial stability and property condition.

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Think of it this way: The Treasury yield moves the baseline rate up or down for everyone. Your association's particular situation determines the lender spread which affects your organization.

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An HOA which operates well and maintains sufficient reserves and shows positive financial performance will receive lower interest rates on their loans. An association with financial challenges might see a larger spread added to their rate.

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What This Means for HOA Boards

Your board needs to understand HOA loan interest rate operations so you can determine suitable responses. Things to watch for include:

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Watch the Right Number

Your board should focus on developing funding strategies rather than spend time following Federal Reserve announcements. The media reports these events, but they do not affect your loan situation.

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The treasurer together with finance committee members need to track the 10-Year U.S. Treasury yield because it will serve as a future reference point. This is your signal. When this number is trending down, borrowing conditions are improving. When it's going up, long-term loans are getting more expensive. This simple piece of information helps you make smarter timing decisions about when to move forward with financing.

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Don't Get Fooled by False Signals

Business operations experience this situation regularly which creates challenges for board members at every experience level to manage it.

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What you see in the news:

• The Federal Reserve pauses rate hikes or even cuts rates
• Headlines suggest that borrowing is getting cheaper

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What's happening behind the scenes:

• The current inflation expectations remain at elevated levels.
• The present economic conditions create doubts among investors about what will happen to market performance in the future.
• The lenders require elevated interest rates to provide funding which spans across 10 years.
• The 10-Year Treasury yield goes up

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The result: HOA loan interest rates increase—even though the Fed hasn't raised its rate or has even cut it.

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The current situation requires boards to move beyond their dependence on Federal Reserve news because it does not provide sufficient information. The Fed controls short-term rates. The market controls long-term rates through the Treasury yield. The two rates sometimes follow two opposite paths 

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Understand the Bigger Economic Picture

The 10-Year Treasury yield experiences movements which stem from actual market factors rather than random events. The market shows its future expectations through this data.

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What drives changes in the 10-Year Treasury yield:

• The expectation of long-term inflation rates determines how investors will behave because they want to protect their investments through higher interest rates when they expect prices to continue rising.
• The worldwide demand for U.S. bond investments leads to lower interest rates because investors seek safe assets during global economic crises.
• The economic growth outlook determines how interest rates will change because rising economic growth leads to higher interest rates, but declining growth leads to lower interest rates.
• The government uses its spending activities and debt management to implement fiscal policy which determines how investors will distribute their funds for lending purposes.

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You don't need to become an economist to understand this. The 10-Year yield changes function as a tool for worldwide intelligent investors to predict future events instead of providing information about present market conditions.

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The Bottom Line on HOA Loan Interest Rates

When you listen to news about the Federal Reserve changing interest rates through their reports you should understand that the Federal Reserve rate does not serve as the primary interest rate which your HOA should monitor when it plans to obtain a fixed-rate loan with extended repayment terms. The 10-Year U.S. Treasury yield functions as the primary element which needs evaluation.

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Boards which select appropriate indicators will achieve better financial management performance.

• You'll be able to evaluate loan offers more accurately
• You could potentially save your community thousands of dollars over the life of the loan
• You'll avoid making decisions based on misleading headlines about Fed rate changes

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The knowledge of HOA loan interest rate operations enables your board to gain a substantial benefit. The system provides you with specific economic factors which determine your borrowing expenses while showing you when your community will benefit from economic conditions.

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Get Expert Help with Your HOA Financing

Navigating HOA loan interest rates and finding the right financing for your community can be complicated. The good news is you don't have to figure it all out on your own.

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At HOA Loan Services, we specialize in helping community association boards and managers get the funding they need to make their communities better. We understand how HOA loan rates work, and we use that knowledge to be your advocate in achieving the best possible financing terms.

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Here's how we help:

• We track market conditions and help you understand when it's a good time to borrow
• We explain loan quotes in plain language, so you know exactly what you're getting
• We provide financial modeling tailored to your community's unique situation
• The team provides straightforward loan quote explanations which help you understand all details of your loan agreement.
• Our financial modeling service creates models which meet all requirements that your community needs.
• The team at our organization will guide you through all loan process stages so you can focus on serving your community.

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Our team helps you make financial decisions which will benefit your community through major capital improvement projects, debt refinancing, and evaluating financing options.

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Ready to discuss your HOA's financing needs?

Contact HOA Loan Services today to learn more about how we can help your community achieve its financial goals.