A Line of Credit Is a Safety Net. Use Sparingly.

There are many ways to look at a line of credit. Some co-op boards see it, correctly, as a safety net, a rainy-day fund, a pot of money that can soften the sting if the building gets hit with an unforeseeable expense. Other boards see it, unwisely, as a way to plug gaps when operating expenses outrun the budget. And some boards see it the way Linus, of “Peanuts” fame, sees his security blanket: it may not do any good, but it sure does feel good to know it’s there. 

Before acquiring a line of credit from a lending institution, a co-op board should know exactly what it is and how much it costs, the right ways and wrong ways to use it, and the smart way to pay it back. 

“Lines of credit became very popular in the ’80s and ’90s, when accountants, lawyers, and property managers advised boards to get one,” says Patrick Niland, president of the mortgage brokerage First Funding of New York. “It’s a convenience, like an overdraft fund on a checking account, or a back-up to the reserve fund. It’s a loan subordinate to the co-op’s underlying mortgage. It can be secured, or it can be unsecured, backed only by the good faith of the co-op. If it’s unsecured, the board avoids the mortgage recording tax – which is 2.05 percent for a line of credit up to $500,000, and 2.8 percent for a line of credit larger than that.” (New York City’s mortgage recording tax is among the highest in the nation.) 

Niland points out other drawbacks. While proponents of credit lines note that they have to be repaid only if they’re used, Niland counters that some banks impose a small fee – usually a quarter of a percent – on the unused portion of the fund. Beyond that, banks charge a variable interest rate on all money that’s drawn from a line of credit. While interest rates are still relatively low, this breaks one of Niland’s cardinal rules. “A basic tenet of finance,” he says, “is that you never use variable-interest debt to pay for a long-term asset, like a new roof or windows. You want a fixed-rate loan – either by taking out a second mortgage, or by borrowing enough on your first mortgage.” 

Consulting with an engineer on the condition of the building’s systems can help boards determine how much they need to borrow to cover such foreseeable repairs. It’s the unforeseeable repairs – a boiler that fails in mid-January, surprise violations from city inspectors – that make a line of credit attractive to many boards. 

“It’s a good tactical tool, but it needs to be used judiciously,” says Gregg Winter, president of the mortgage brokerage Winter & Company. If a board dips into its line of credit to pay for an unexpected expense, Winter stresses that there must be a plan for paying back the debt. This can be done through an assessment, or with funds from a flip tax, or simply by building the debt into the new loan the next time the board refinances its mortgage.

“Each board will have to have that discussion,” Winter says.