Multifamily loans insured by the Department of Housing and Urban Development are often some of the best financing options available to investors. HUD loans have comparatively longer loan terms than most other commercial mortgages, are fully amortizing, have minimal debt service coverage ratio requirements, and offer some of the lowest fixed interest rates in the industry.
The Department of Housing and Urban Development offers some of the lowest-rate and longest-term apartment loans in the industry, including the HUD 221(d)(4) program, a 40-year fixed-rate and fully amortizing loan for apartment construction and rehabilitation.
Benefits Of HUD Commercial Loans
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.
HUD multifamily loans offer competitive interest rates, long terms, high leverage allowances, and are fully amortizing and non-recourse. In addition, HUD multifamily loans are fully assumable (with HUD/FHA approval). That makes these loans highly effective for borrowers who want to maximize their profits and reduce their financial risk.
HUD multifamily loans also offer additional benefits for affordable properties and are a great candidate for Low-Income Housing Tax Credits (LIHTCs), as well as housing located within Opportunity Zones. They can also work well with the Rental Assistance Demonstration (RAD) program, which allows certain properties under HUD legacy programs for affordable properties to convert their housing to the HUD Section 8 program.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
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Are HUD commercial loans difficult to qualify for?
HUD commercial loans have strict eligibility requirements, but if you meet these requirements, they can be a great option for financing your apartment development project.
Can I use a HUD commercial loan to renovate an existing apartment building?
Yes, HUD commercial loans can be used for both new construction and renovations of existing multifamily housing properties.
How long does it take to get approved for a HUD commercial loan?
The approval process for HUD commercial loans can take several months, so it’s important to begin the application process well in advance of your project start date.