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Top 5 Advantages of HUD Construction Financing
HUD loans typically have some of the best terms for multifamily properties — and they’re not just for affordable housing. Find out how a HUD 221(d)(4) loan could work for you.
Loans backed by the Department of Housing and Urban Development are often pointed to as among the best in the multifamily finance space. And it’s true: Loans backed by the Federal Housing Administration have, far and away, some of the most attractive terms out there. This article will specifically look at HUD’s most popular construction financing option, the HUD 221(d)(4) loan.
Although HUD 221(d)(4) loans are broadly used for ground-up developments, they also are invaluable resources for major renovations and rehabilitations on a property. Below, we will discuss the top five advantages of using HUD 221(d)(4) loans. That’s not to say these loans are perfect, of course. In commercial real estate transactions, timing can be everything — and these loans can take a very long time from application to close. That said, there are ways around some of these drawbacks, including through the use of bridge-to-HUD financing.
Want to talk through your options for your next development or rehabilitation? Reach out to us by completing the form below. Otherwise, read on to learn the top five advantages of using HUD construction financing.
1. Extremely high leverage
HUD loans across the board are well known for allowing some of the highest loan-to-value ratios in the multifamily industry. This is especially true for HUD 221(d)(4) financing, which typically allows for a loan-to-cost ratio of up to 85% — far higher than any Fannie or Freddie loan or other conventional financing product.
And that’s just for market-rate properties. If you are planning to develop a property with an affordable housing component, an LTC ratio of up to 87% is possible. Granted, this will require a regulatory agreement to be in place for a specified period of time — say, a commitment to reserve 20% of units for households earning a maximum of 50% of area median income — but this requirement may not be much higher than local affordable housing requirements for new developments.
Finally, if the property is a subsidized housing development, meaning 90% of the units are covered by a project-based Section 8 contract or covered by Low-Income Housing Tax Credits restrictions, a HUD 221(d)(4) loan can have a maximum loan-to-cost ratio of up to 90%.
2. Long, fully amortizing terms
Another major perk of HUD 221(d)(4) financing is the lengthy, fully amortizing loan terms on offer — not dissimilar to a conventional home loan. The term truly is longer than almost anything else on offer, with allowances for a three-year construction period (with interest-only payments) plus a 40-year term after. Furthermore, monthly payments are low and predictable for the entire term, thanks to a fixed interest rate throughout the life of the loan.
3. Fixed interest rates
While many loan products include fixed interest rates, HUD loans’ interest rates trend lower than nearly any other kind of financing. For all HUD loans endorsed between January and September 2022, the fixed interest rates averaged 3.35%, according to data provided by the department. Of course, as interest rates have risen across the board, so too have HUD rates — but they remain among the lowest available.
Best of all, borrowers are able to elect to lock the interest rate early on in the application process. While it requires a deposit equal to 1% of the loan’s amount — which is refunded at closing — this can be a great way to ensure advantageous debt costs, particularly when rates are expected to rise more.
4. Low DSCR requirements
HUD’s 221(d)(4) loan also allows for some of the lowest debt service coverage ratios out there. The minimum DSCR allowable for a market-rate property, at 1.18x, gives it yet another edge over other financing options. And, like with loan-to-cost ratios, HUD’s DSCR requirements relax for affordable and subsidized properties, allowing for minimums of 1.15x and 1.11x, respectively. By comparison, Fannie Mae typically requires a more conservative DSCR of 1.25x, with Freddie Mac loans allowing for minimums of 1.20x depending on the market.
Why does this matter? As DSCR compares a property’s income with its debt obligations, it is a key metric lenders use to assess the risk of default. If a debt coverage ratio is less than 1, that essentially means the property’s net operating income isn’t sufficient to cover the debt service. Allowing for a lower DSCR simply means that HUD is willing to insure loans on assets that may appear slightly riskier.
5. Fully assumable
One of the most significant advantages of HUD 221(d)(4) debt is that the loans are fully assumable. What does this mean? Should an investor sell a property encumbered by a HUD loan, the buyer can take on this debt and benefit from all of the items mentioned above. Of course, the lender and the FHA will need to approve any transfer, but once this is complete, the fee involved is relatively small — just 0.05% of the original loan balance.
In an environment with rising interest rates, this offers a key advantage to taking out a new loan, even if it’s also at a fixed rate. Assumption approvals also typically take far less time than taking out new financing for an acquisition, so there’s plenty of incentive for a buyer to go through this process.
Related Questions
What are the benefits of HUD construction financing?
HUD construction financing offers many benefits, including extremely high leverage, fixed interest rates, and more.
HUD loans across the board are well known for allowing some of the highest loan-to-value ratios in the multifamily industry. This is especially true for HUD 221(d)(4) financing, which typically allows for a loan-to-cost ratio of up to 85% — far higher than any Fannie or Freddie loan or other conventional financing product. And that’s just for market-rate properties. If you are planning to develop a property with an affordable housing component, an LTC ratio of up to 87% is possible. Granted, this will require a regulatory agreement to be in place for a specified period of time — say, a commitment to reserve 20% of units for households earning a maximum of 50% of area median income — but this requirement may not be much higher than local affordable housing requirements for new developments. Finally, if the property is a subsidized housing development, meaning 90% of the units are covered by a project-based Section 8 contract or covered by Low-Income Housing Tax Credits restrictions, a HUD 221(d)(4) loan can have a maximum loan-to-cost ratio of up to 90%.
While many loan products include fixed interest rates, HUD loans’ interest rates trend lower than nearly any other kind of financing. For all HUD loans endorsed between January and September 2022, the fixed interest rates averaged 3.35%, according to data provided by the department. Of course, as interest rates have risen across the board, so too have HUD rates — but they remain among the lowest available. Best of all, borrowers are able to elect to lock the interest rate early on in the application process. While it requires a deposit equal to 1% of the loan’s amount — which is refunded at closing — this can be a great way to ensure advantageous debt costs, particularly when rates are expected to rise more.
What are the requirements for HUD construction financing?
HUD 221(d)(4) loans have several requirements for construction financing. The general contractor must pay Davis-Bacon wage rates (required by the Department of Labor). After construction is completed, both the general contractor and owner must submit a cost certification. In addition to submitting the required general contractor information, the general contractor must also provide either:
- a 100% performance and payment bond
- or a 15-20% cash escrow
- or a FHA-accepted letter of credit
The general contractor must also have a liquid net worth of at least 5% of the project’s construction contract and additional uncompleted construction work.
For more information, please visit hud221d4.loan/general-contractor-requirements and hud221d4.loan/developer-requirements-fees.
What types of projects are eligible for HUD construction financing?
HUD 221(d)(4) financing is available for a broad spectrum of developments, including market-rate, low-to-moderate income, and subsidized multifamily, cooperative housing, and affordable housing properties with at least five units. In order to be eligible for HUD 232/223(f) financing, a project must house 20 or more residents, provide ongoing medical care for long-term patients, be licensed by the appropriate municipal or state organization/agency, have been constructed least three years ago, have no more than 20% of the project's gross area or gross income devoted to/derived from non-resident day care, have no more than 25% of all units designated as independent living units, and have no more than 20% of the gross floor space filled and no more than 20% of the property's income derived from commercial tenants.
Sources: HUD 221(d)(4) Construction & Rehab Loans and HUD 232/223(f) Loans
How does HUD construction financing compare to other types of financing?
HUD construction financing offers some of the lowest interest rates available, with fixed interest rates that have averaged 3.35% according to data provided by the department. Additionally, HUD loans offer long, fully amortizing loan terms with allowances for a three-year construction period (with interest-only payments) plus a 40-year term after. Furthermore, monthly payments are low and predictable for the entire term, thanks to a fixed interest rate throughout the life of the loan.
For more information, please see the following sources:
What are the advantages of HUD construction financing over other types of financing?
HUD construction financing offers several advantages over other types of financing. One of the biggest advantages is the extremely high leverage that HUD loans offer. HUD loans across the board are well known for allowing some of the highest loan-to-value ratios in the multifamily industry. This is especially true for HUD 221(d)(4) financing, which typically allows for a loan-to-cost ratio of up to 85% — far higher than any Fannie or Freddie loan or other conventional financing product. And that’s just for market-rate properties. If you are planning to develop a property with an affordable housing component, an LTC ratio of up to 87% is possible.
Another advantage of HUD construction financing is the fixed interest rates. While many loan products include fixed interest rates, HUD loans’ interest rates trend lower than nearly any other kind of financing. For all HUD loans endorsed between January and September 2022, the fixed interest rates averaged 3.35%, according to data provided by the department. Of course, as interest rates have risen across the board, so too have HUD rates — but they remain among the lowest available. Best of all, borrowers are able to elect to lock the interest rate early on in the application process. While it requires a deposit equal to 1% of the loan’s amount — which is refunded at closing — this can be a great way to ensure advantageous debt costs, particularly when rates are expected to rise more.
What are the disadvantages of HUD construction financing?
The disadvantages of HUD construction financing include:
- Requires a variety of third-party reports, including environmental assessments, architectural and engineering reports, and full HUD/FHA appraisals
- Requires an FHA application fee of 0.30% of the loan amount and a 0.50% FHA inspection fee
- Requires a one-time mortgage insurance premium (MIP) at closing, and payment of monthly MIPs throughout the duration of the loan