What is a sinking fund?

When you live in an apartment or shared building, there are going to be certain repairs and works that benefit everybody. Walls, external drains, communal areas. Everyone in the building uses them, and so everyone has a responsibility for their upkeep. But this begs the questions: who's responsible for covering the cost?

That's where a sinking fund comes in. Think of it like an emergency fund to cover the cost of future repairs or planned expenses for the whole development. They can even act as a savings account to help cover any unexpected expenses for the property. That way, everyone pays their fair share of the cost, no one feels out of pocket, and everyone (including future buyers) can benefit from the joint work.

But what exactly is a sinking fund? How are they collected, and how do you know how much to contribute?

What is a sinking fund?

A sinking fund helps to pay for future works and major repairs to communal areas of apartment buildings or leasehold properties. Residents living in these properties will make sinking fund contributions over a period of time which are then set aside to help cover these works. You'll get details of what your sinking fund covers when you purchase your new home, and if and when your contributions are revised.

Sinking funds are fairly common with leasehold properties. It'll usually be part of the service charge contribution that's payable by each leaseholder, and calculated as a fixed percentage of the service charge. Reviewed on a regular basis, the amount payable is put into an interest bearing bank account.

If you own the property freehold, you'll still have to pay a service charge if there are communal areas like a shared garden or parking.

What is the sinking fund money used for?

Sinking funds are used to pay toward large expenses or repairs that may need doing at a later date, such as:

• Replacing external doors and windows.
• Replacing roofs, guttering and walls.
• Parking areas including fencing, signboards and footpaths.
• External drains and plumbing systems.
• Door entry phone systems.
• Communal carpets.
• Communal electrical systems such as TV aerials and lighting.

How sinking funds are calculated

Usually, sinking funds are calculated by estimating how much it costs to replace certain items, and the life span of each item before they need repairing. The fund is regularly reviewed to ensure there's enough to cover any larger expenses. Sometimes, if the funds have been underestimated, the residents will be charged for the money left once the works are finished.

For example, management companies will calculate how much it costs to pay for a replacement lift, as well as the time it takes before this type of repair needs to be done. This is calculated into the yearly figure, which is then included as part of the total yearly charge each resident pays towards the sinking fund.

Other examples of home repairs where a sinking fund helps to cover the cost include plumbing systems, footpaths, signboards, communal electrical systems, and other communal areas.

Sinking funds can also be set up by private landlords who set aside some money collected from the ground rent each month.

Your lease agreement will set out how you need to pay towards the sinking funds. Some require a lump sum to be paid, while others ask for monthly payments.

How sinking funds are collected

Sinking funds (also commonly referred to as reserve funds) are generally collected through service charges. They'll be held in a trust account where the interest is added to the fund each year. Leaseholders will get an annual statement at the end of the financial year detailing the balance of the fund which includes how much interest has been earned after tax.

Leaseholders will pay service charges and a certain amount of that payment is transferred from the current account into the reserve fund. It's similar to how savings accounts work: you're placing money from your current account into a savings account.

Selling your property and sinking funds

When you sell your property, your buyer's solicitor usually asks if there's a sinking fund to cover major works. Everything you contribute to the fund will stay in the sinking fund attached to your property if you decide to sell it.

Service charges

Examples of works that are covered by service charges include:

• Cleaning the communal hallways and staircases.
• Communal water supply charges.
• Maintaining communal courtyards and gardens.
• Any day-to-day repairs to the communal areas or structure of the building.
• Electricity costs for lighting in communal areas.
• Buildings and public liability insurance.

Sinking funds versus service charges

Service charges are used to cover common home repairs like stairwell damage. On the other hand, a sinking fund helps to cover major work like a new roof, or the replacement of an entire bannister.

This means the day to day expenses of running the development are covered by the service charges, which are held in the current account. The sinking fund shouldn't be used to cover these costs or offset any under budgeting.

The benefits of sinking funds

Having a sinking fund often improves your home's saleability and helps maintain its value. All the contributions you make stay in the fund attached to the property if you decide to sell, which means buyers are reassured that they're covered if there are large or unexpected expenses in the near future. It means everyone pays a fair amount, and it doesn't just fall to one owner to cover major work and replacements.

A sinking fund ensures there are funds immediately available to pay for urgent and significant repairs, meaning leaseholders will feel much less out of pocket. It also means landlords can plan for expected works knowing there's enough money to cover it.

The cons of sinking funds

Sinking funds do generate a few disadvantages, including:

• Increased annual running costs of the flat through sinking fund contributions.
• There can be disputes between leaseholders and landlords (or management companies) about how the funds are being used and how they're being calculated.
• Sometimes it can be difficult to get the funds released if they don't end up being used.
• The contribution from sinking funds aren't always included in the service charge contribution, so you may have to double check your specific lease arrangements.

Contributing to a sinking fund

Is it compulsory?

Your lease agreement will tell you whether or not it's compulsory to contribute to a sinking fund. So remember to thoroughly read your agreement if you don't want to purchase a property with a sinking fund!

Challenging the amount you pay

If you have any concerns about your sinking fund or service charges, your first port of call should be to contact the landlord or management company. They'll be able to outsource an independent surveyor who can assess the charges to make sure it's fair for everyone.

If you can't reach an agreement, you'll have to apply to the First Tier Tribunal (which handles property disputes) to find a resolution. They're made up of solicitors and surveyors who will be able to settle any disagreements about services and the service charge of your property, including the sinking fund.

Are sinking funds refundable?

Most of the time, money you put into the sinking fund is non-refundable, unless otherwise stated in your lease agreement. This is because it's in the leaseholders interests for the fund to be accessible for generations of owners, not just the current one.

Reserve fund versus sinking funds

Though reserve funds and sinking funds have often come to mean the same thing, there are technically some distinctions. Management companies have a right to charge additional funds as part of the service charges to place in a reserve fund. The reserve fund can accrue over two or three years, and can be used to pay for any works that weren't covered by service charges.

The reserve fund must have a reasonable amount of money in it; the money set can be challenged if the leaseholders don't think it's a fair amount or if they think the funds are being mismanaged.

Notifying leaseholders of works

Under the Landlord and Tenant Act 1985, freeholders have to consult with leaseholders if the works will cost more than £250. If they're not informed of this, the cost can be capped at £250 per leaseholder even if the works cost much more money.

Summary: The sinking fund stops residents from going under!

Ultimately, a sinking fund can be seen as a great asset to your property. Not only does it benefit the community by helping them save money and avoid huge one-off charges, it's also really attractive to prospective buyers. They have peace of mind knowing any immediate repairs are probably covered by the sinking fund.

So if you're selling a house with a sinking fund, make sure you inform any potential buyers' solicitors, because it really could amp up the value of your home. To explore the current value of your property, you can use our Online Valuation Tool for an instant valuation. And if you're ready to sell, check out our Estate Agent Comparison Tool to find the right agent for your needs!