Lining Up the Debt FHA Products Offer Options for LIHTC Developers

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By Jeffrey D. Banker, Lancaster Pollard Mortgage Company

Tax Credit Advisor, March 2010: Low-income housing tax credit developers are used to turning over numerous stones to finance construction or rehabilitation projects Ð grants, bank loans, HOME loans, etc. But in the aftermath of the financial meltdown, many developers have been left to fill funding gaps caused by the loss of permanent financing commitments, or face much more limited options for construction financing.

One financing option that has stood strong, however, is the U.S. Department of Housing and Urban Development’s Federal Housing Administration (FHA) multifamily mortgage insurance loan programs. HUD has recently made changes to these programs to make them more workable for tax credit projects.       Historically, FHA developers developed FHA projects, and LIHTC developers developed tax credit projects, with little crossover. Tax credit developers were reluctant to use FHA insurance due both to economics and to processing constraints that extended the development timeline. Traditionally, FHA loans required all project costs to be funded at closing. This placed significant pressure on LIHTC equity pricing, because of the requirement that almost all equity be put in up front rather than as-needed over time as is typical with conventional financing.

Recent policy and personnel changes at HUD have brought tax credit experience to FHA, and have made the use of FHA financing with tax credits much more similar to typical bank financing. For instance, today a minimum of 20 percent of tax credit equity must be posted at closing with an FHA loan.

In addition, HUD has temporarily relaxed a standard restriction on refinancing. Generally, projects not originally financed by an FHA loan must wait three years before they can obtain an FHA loan to refinance. In 2009, HUD relaxed this requirement to open the door to FHA financing to developers who lost their conventional permanent financing commitments in the market tumult.

How FHA Programs Work

FHA offers several multifamily loan programs, which vary by type of project and borrower. These FHA loan products can provide debt for new construction, substantial rehabilitation, refinance, or acquisition and moderate improvements. Arguably the most enticing for tax credit developers is the Section 221(d)(4) product (see chart for details of products).

Borrowers will notice little difference in FHA’s treatment of either 9 or 4 percent tax credits compared to traditional bank loan underwriting. The biggest differences are in the application process and post-closing requirements.

FHA multifamily loan program features include:

  • Non-recourse fixed-rate financing.
  • Amortization periods of up to 35 or 40 years.
  • Credit enhancement to provide an interest rate equivalent to AAA-rated financing.
  • Construction and permanent financing in a single loan.
  • Interest rate fixed at construction closing for the life of the loan.

FHA programs are well-respected by investors and the capital markets. This means that the use of FHA insurance can reduce a borrower’s interest rate by up to a full percentage point compared to other forms of credit enhancement. In February, borrowers saw construction loan coupon rates in the 5.7 to 5.9 percent range.

What to Expect

Part of the market respect for FHA programs comes from its strong underwriting history. Borrowers accustomed to negotiating bank financing must recognize that with FHA, while waivers can be obtained, they generally must adhere to criteria that include:

  • Minimum debt service coverage of 1.11 for new construction or 1.17 for refinance, with the expectation that higher ratios will likely be required in the current weaker market.
  • Other financial ratios similar to those required by banks.
  • Market study/appraisal
  • Payment of Davis-Bacon minimum labor wages.
  • Prepayment lockout
  • Monthly escrows for property insurance, taxes, replacement reserves, and mortgage insurance premiums.

Borrowers apply for a HUD-insured loan through an FHA-approved lender. For LIHTC projects, borrowers should seek a lender experienced with tax credits; not all are. The lender completes the credit narrative and application, coordinates deadlines, and helps ensure that all requirements (including insurance) are met early on. 

LIHTC developers and their projects are scrutinized during the FHA application process. Borrowers must be prepared to provide detailed operating histories and credit references, and an FHA representative will visit the site. All members of the borrowing entity must be U.S. citizens; any necessary legal changes to conform must be made before the transaction closes.

Borrowers pay an annual mortgage insurance premium and up-front inspection and closing fees. After the closing, borrowers are subject to ongoing compliance, reporting, and insurance requirements.

Conclusion

FHA requires strict adherence to the eligibility requirements for its multifamily loan programs. But this rigid underwriting standard and the federal mortgage guarantee that comes with FHA financing have burnished the reputation of FHA loan programs among investors, such that the interest rates on FHA loans are generally some of the lowest available.

FHA financing can take longer to obtain than typical bank financing or loans backed by Fannie Mae or Freddie Mac. However, the maximum 35- to 40-year amortization period, the non-recourse nature of HUD loans, and the lack of permanent financing conversion risk make FHA financing a compelling option for a developer in any market, and especially in the current low-interest-rate environment.

Jeffrey D. Banker is a vice president with Lancaster Pollard Mortgage Company, a Fannie Mae/GNMA/HUD-FHA/USDA-approved lender and one of the nation’s leading providers of financing for affordable housing. He can be reached at 614-224-8804 or [email protected].