Replacement Reserves- Understanding the Fundamentals
Long and short-term housing rental businesses use a financial operations tool to maintain, repair and upgrade the physical facilities. This tool is known as replacement reserves in the real estate industry. In almost all cases it is a contractual agreement requirement between the mortgage lender and the borrower. The financial arrangement between the parties is simply a stipulated amount paid monthly to the mortgagor who holds the funds in trust. At agreed increments the borrower submits receipts to the mortgage company of actual maintenance, repairs and upgrades for reimbursement.
There are several underlying fundamentals of replacement reserves every owner and manager of housing rental operations must understand to correctly implement, utilize and comply with the terms of the mortgage note. In addition there are accounting issues related to replacement reserves that should be followed so as to present fairly the financial results of this activity. To assist the reader in understanding the fundamentals of replacement reserves this article explains the logical and legal framework of replacement reserves; how good planning and budgeting assist in utilizing the proceeds held in trust; and finally, how compliance requires proper accounting.
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