With HUD rates nearing 2%, nearly 75% of HUD’s current multifamily/healthcare portfolio is potentially refinance-able. Locking in a fixed 2% rate, non-recourse loan for 35 years is the deal of the decade - especially since HUD loans are assumable, which means you can sell the property with the loan attached.
If you’re looking for up to date pricing or want to review live a7 terms, we’ve created an app for that: a7.tapcap.co
This post is written with current HUD borrowers in mind, though any multifamily owner willing to consider HUD financing should take note.
The “a7” Refinance
The standard HUD refinance is the HUD 223(f), which every HUD borrower has gone through. It’s the trial by fire, the gauntlet for multifamily mortgages, the initiation to get into HUD’s insured club. Current HUD borrowers can choose to put themselves through that again, but there is a streamlined alternative, an express-lane: The HUD 223(a)(7) (aka “a7”).
The a7 is not a typical refinance - the process is more similar to a loan modification. We’re going to go through the important terms and options available to you. We’ll also compare an a7 execution with a typical 223(f), as well as a straight loan modification (also known as an interest rate modification, “IRR”).
This is a long post - here is a quick outline if you want to jump to a specific section.
- Eligibility: Does my loan qualify?
- Loan Amount: How Much Can I Take?
- Interest Rate: How Is My Rate Set?
- Paying the Prepayment Penalty: Using Trade Premium to Your Benefit
- New Prepayment Penalty: You have Options
- Loan Term: Extending the Amortization Schedule
- Vendor Reports: What’s Required
- Going Green: Saving The MIP
- Transaction Fees: How Much Will the Transaction Cost?
- Due Diligence Requirements
- Comparison: a7, IRR and 223(f)
- TapCap A7 App: Because of course we need an app
Eligibility: Does my loan qualify?
You are good if your project was originally financed under the 223(f), 221(d)(4) or a previous 223(a)(7). The loans that are not eligible are risk-share/co-insured loans (e.g. section 542) or section 202 loans (affordable elderly care).
The a7 is used to benefit the existing structure, as-is, with routine maintenance or enhancements. The a7 is not to be used for structure expansions, new constructions, extensive rehabilitation or any work that involves ground disturbance.
If your previous HUD loan is re-subordinated under a PPC loan (partial payment claim), you are still eligible.
Loan Amount: How Much Can I Take?
The new loan amount will be the minimum of three factors, the original principal amount, the proposed DSCR and the overall costs to refinance.
Original Principal Amount
What’s interesting about the a7 is that there is no reevaluation of the properties value. No appraisal or market study is necessary.
That is why the maximum loan amount is the original principal amount on the existing mortgage.
For example, if 9 years ago you financed your property under a 223(f) for $10M, your amortized principal balance today would be around ~$8M. Even if your property value has increased, the maximum loan amount would be $10M, the original loan amount.
Debt Service Constraint
In addition to the above, the property must maintain a DSCR of 1.11 (1.05 if property has >90% project based Section 8 units). For a $10M a7 with a 2% rate (and assuming a 35yr term), your monthly debt service payment would be $33,126. To qualify, your property would have to have a monthly net operating income of:
Cost of Refinance
Borrowers cannot use the a7 to simply “cash-out”. The proceeds must be used for eligible costs. Let’s go through the eligible costs with an example.
Let’s use our previous example, where we originally financed our project with a $10M 223(f) 9 years ago. Our outstanding loan balance is ~$8M. We start there:
All transaction fees are eligible, including the CNA report, title, legal, the application fee, etc. Let’s assume total costs, including 50% of MIP is $115,000
Prepayment penalties are eligible. Let’s assume, since 9 years has passed, the prepayment penalty is 1% of the outstanding balance:
That still leaves us with $1,770,260 left until we hit the original loan amount. What can we use this for?
Putting aside cash for critical, non-critical maintenance and the replacement reserve is eligible. The replacement reserve can be used for normal unit turnover and other routine maintenance.
Unit renovations are permissible as long as the aggregate cost does not exceed $1,500 per unit (excepting repairs that make the unit accessible to persons with disabilities).
Work requiring an environmental review is not eligible.
Let’s assume we put aside $450,000 for unit renovations and future repairs reserves. Note, your current repair reserve will transfer over - so this is in addition to that reserve.
|Repairs & Replacement Reserve||$450,000|
Our final loan amount is $8.68M. In addition to the amount the CNA report recommends, you can decide how much you want to put aside for repairs. You can always decide to not take out additional funds.
Interest Rate: How Is My Rate Set?
A common misconception many borrowers have is that their HUD rate is a function of the overall risk-level or geography of the project. In the case of HUD financing, this has nothing to do with your rate.
Surprisingly, all HUD a7’s are eligible for the same interest rate.
$5M, 50 unit properties in Utah and $50M 500 unit properties in Tennessee can both receive the same rate.
The rate you see on lender term sheets factor in 3 items: the market “par” rate, premium to be raised to pay off prepayment fees, and lender profit.
If you aren’t comfortable with bond pricing and trade premiums, here is our post stepping through these concepts.
Your lender will likely securitize your loan through a GNMA certificate and sell the security on the open market. The price investors pay for the GNMA is a function of the interest rate, loan term and prepayment schedule. The price investors will pay for the GNMA security is explained here.
The interest rate for a par trade changes constantly, with every transaction influencing the rate, similar to how stock trades influence the bid-ask. Your lender will try to establish where they believe par is at the time of quote and at the time of rate lock with you. Keep in mind, this number is constantly changing, so you should ask your lender to update you on where market par is (or use our TapCap app, which tracks the 102 rate).
As of recent, par for a typical a7 (35yr term, 10 year declining prepay) has been around 1.9%, so we’ll start there.
Premium Used to Payoff Prepayment
As you know now, a slight increase in your loan’s interest rate can generate a large cash sum when sold in the form of a trade premium. This cash sum can be used to pay off prepayment penalties.
Keep in mind, prepayment penalties are a mortgageable expense. Trade premium should be used to pay off the remaining amount of prepay penalty that cannot be covered by the new loan.
Let’s assume your loan has a 7% prepayment penalty, 5% of which is not covered by the new loan. The lender can raise your interest rate to a level that would generate a 105 trade price and use that 5% to pay off your prepayment entirely. Similar to determining the par rate, lenders can look at current GNMA transactions to extrapolate what interest rate would generate a 105 trade. This amount, like par, constantly changes.
To make the matter slightly more difficult, the difference in rate between a 100 (par) trade and a 105 trade isn’t always the same. For the last decade, the common spread is ~12.5 bps in rate per 1% in trade premium. That would mean that typically to achieve a 105 rate, we’d have to raise the rate by:
However, recently the spreads have been more compressed. Currently it costs ~50bps additional to achieve a 105. In other environments, it may be more.
Back to our example, let’s assume it is an additional 50bps to achieve a 105 and completely wipe out your prepayment penalty:
|Premium for Prepayment Penalty||0.50%|
Another useful tool of trade premiums is waiving upfront lender fees in return for a slight increase in rate, effectively financing the lender fee. Lenders can use the cash from the trade premium to make up for discounted upfront fees.
Historically the fee lenders charge varies significantly, and can be anywhere from 1% to over 7%! The typical range is between 3% and 5%.
For the purposes of our example, we’ll (shamelessly) use TapCap as the example. TapCap has partnered with a few select HUD lenders to offer a7 loans at a 2% fee all-in. You can decide whether you want to pay that fee upfront, finance it in the rate, or some combination of both (e.g. 1% upfront, 1% financed).
If you choose to finance the rate entirely through trade premium, the lender now has to achieve a trade premium of 107 (105 for prepay + 2 for fee).
Note, as the trade price increases, each percentage point of premium becomes more expensive and requires more bps in adjusted rate. For instance, 105->106 may be 12.5bps, where as 106->107 may be 15bps
Let’s assume we have to raise the rate an additional 25bps to cover the fees, our rate now is:
|Premium for Prepayment Penalty||0.50%|
GNMA & Servicing Fee
GNMA charges a 12.5bps fee for their insurance. Your servicer also receives 12.5bps for servicing.
|Premium for Prepayment Penalty||0.50%|
|GNMA & Servicing||0.25%|
The exact numbers constantly change due to market forces, however your lender should be able to provide clarity on these parts. TapCap also provides this information.
Paying the Prepayment Penalty: Using Trade Premium to Your Benefit
The prepayment penalty is an eligible mortgageable expense. However, because the maximum loan amount is constrained by the original Principal amount, there are situations where only a portion of the prepayment penalty can be covered by the new loan.
For example, let’s say we financed a project 3 years ago with a $10M HUD 223(f). Today, the outstanding principal balance is $9.37M, and the prepayment penalty is 7%, or ~$656,000. Let’s assume transaction costs are $115,000, how much prepayment penalty is leftover?
|Original Loan Amount||$10,000,000|
|Leftover Prepay Fee||$140,900|
Note: Trade premium cannot be used to pay transaction fees - only the prepayment penalty
Now we are left with a $140,900 prepayment penalty, 1.4% of our new loan.
You have three options to pay the remaining cost: out of pocket, trade premium or a combination of both.
Out of pocket is the most straight forward. You keep your interest rate low and just pay off the fee out of pocket. However, considering how cheap HUD debt is, this is rarely the most economical.
Trade Premium is typically the best route for smaller prepayment amounts. As discussed in the previous section, a ~20bps raise in rate (or wherever a 101.5 trade might be) would cover the $140,000 penalty.
That 20bps increase on a $10M a7 would amount to ~$12,500 in increased annual debt service, so it’s better to pay the extra 20bps and keep the $140,000 in your pocket.
Hybrid is a combination of paying a portion of the prepay with trade premium and the remainder out of pocket. If the cost per point remains around 12.5bps, it makes sense to use trade premium. However for large prepay fees where you might have to raise 8 points or more, the increase in rate per point in premium becomes more expensive (e.g 25 bps in rate for an additional 1% in premium). Once you get to high premiums, it might make sense to pay a point or two upfront, especially if you are planning on holding the project long-term and want to secure the lowest rate possible.
New Prepayment Penalty: You have Options
That you are able to customize the prepayment schedule comes as a surprise to many borrowers. While HUD requires at least 5 years of prepay term for a 223(f), that doesn’t exist with a7s.
Changing the prepay schedule does change the price an investor would pay for your loan. While our post on bond prices goes into detail, the intuition is pretty simple. A loan with 5 years of a prepay term is more likely to pay off early than a loan with 10 years. The more flexible the prepay schedule is for the borrower, the greater the risk of prepay to the GNMA investor and therefore the higher of an interest rate the investor will require.
The most common prepay schedule is a standard 10 year step-down prepay:
10, 9, 8, 7, 6, 5, 4, 3, 2, 1
Another common and similar schedule is a 1 year lockout followed by 9 years of step-down:
LO, 9, 8, 7, 6, 5, 4, 3, 2, 1
However, there are other less common structures that might be more advantageous to you. For instance, you could have a shorter schedule, which would be more expensive but allow for greater flexibility:
5, 4, 3, 2, 1
Or you could have a much stricter schedule, which allows you to obtain an even lower rate, such as:
10, 10, 10, 10, 10, 5, 4, 3, 2, 1
Prepay Schedules by Frequency*:
|10, 9, 8, 7, 6, 5, 4, 3, 2, 1||~60.32%|
|LO, 9, 8, 7, 6, 5, 4, 3, 2, 1||~14.4%|
|LO, LO, 8, 7, 6, 5, 4, 3, 2, 1||~11.1%|
|10, 10, 10, 7, 6, 5, 4, 3, 2, 1||~4.31%|
|Prepays 5yrs 7 under||~4.03%|
*Extrapolated from the GNMA database. The entries in the GNMA database contain many errors - the above percentages are best estimates.
Speak with TapCap to get an idea of what prepayment options are available and the price differences between them.
Loan Term: Extending the Amortization Schedule
The a7 refinance allows you to extend your loan term. Remember, HUD loans are fully amortizing, which means your amortization term is equal to your loan term. The longer your amortization term, the lower your monthly debt payments become.
For this reason, it is common for borrowers to try to extend their loan term as much as permissible.
First requirement - The loan term cannot be greater than 75% of the remaining useful life of the project, as determined by the CNA report.
Second, the new loan term can be extended to whichever is lower: 12 years from the current maturity date or the maximum allowable term under the section of the act (e.g. 223(f).
Example: Your current loan term was financed under HUD section 223(f) and is 420 months (35 years). You’ve passed month 96 (8 years):
|12 year extension||468 months|
|Max allowable under 223(f)||420|
|New Loan Term||420|
Note: If this is an a7 of a previous a7 loan, the 12-year extension is based on the first loan, not the a7- i.e. you cannot keep extending the term over and over again.
Of course you are not obligated to extend your loan term for the maximum duration, or at all.
Vendor Reports: What’s Required
Another great part about a7’s is how few vendor reports are required. No environmental, no market study, no appraisal! The only report required is the Project Capital Needs Assessment (PCNA, aka CNA).
In the event that you would like to apply for the Green MIP Reduction (details in the next section), an energy audit can be included in the PCNA report.
Furthermore, in the event that you have had a PCNA performed in the last 2 years, that report may be eligible.
At closing, you’ll need a title report, as well as either a survey affidavit certifying the existing survey is valid or a new survey.
That’s it. Nice.
Going Green: Saving The MIP
Unlike other lending programs that are only beneficial when converting to an energy efficient property, HUD will give you the discount whether you are going green, or are already there.
By qualifying for the Green MIP discount, you get to reduce your MIP (Mortgage Insurance Premium) to 25 bps. That’s a pretty significant discount, and it’s worth considering.
If you do not already have a score, the requirements to get a score involve collecting all of the utility bills from all tenants - which is typically a pretty large ask. Multifamily properties can install individual meters that allow the collection of energy usage much more easily, and the good news is that the a7 can be used to cover those costs.
Your best bet if you are not currently Energy Star certified is to tack-on an energy audit (specifically an ASHRAE II) when hiring the PCNA vendor. This report will estimate the costs of going green, as well as the potential savings from the energy efficient appliances.
You do not need to be Energy Star Certified upfront to achieve the Green MIP discount - but you do have to commit. If you have an energy audit, a SEDI (Statement of Energy Design Intent) and a committed CapEx plan for outfitting the property, HUD will grant you the discount. Just make sure to follow through on the plan within the first 12 months.
Transaction Fees: How Much Will the Transaction Cost?
An example fee schedule for a $10M a7. Keep in mind, all fees are mortgageable. You likely won’t have to pay out of pocket:
|HUD Application Fee||0.15%||$15,000|
|Title & Survey||-||$5,000|
|Financing Fee||-||paid with trade premium|
HUD Application Fee
This is HUD’s fee for reviewing the application. It’s cost is 15bps (interesting, since the amount of processing required doesn’t differ between large and small loans, but the fee does…).
First year of MIP is due upfront. That is typically 50bps for market-rate, 35bps for affordable properties and 25bps for green.
It is typical for the lender to forward it’s legal expense on to your loan, typically in the amount of $20,000. Your own legal expenses are an additional amount (typically somewhat less than the lender’s but that is dependent on which firm you use). Both are mortgageable.
Standard PCNA report is ~$7,500.
The additional energy audit may vary, but is typically priced around $0.15/sq ft.
Title & Survey
This should be around $5,000.
Financing, Placement, Broker Fees
These can vary between lenders. For most a7 transactions, lenders keep the upfront financing fee low and make the rest up in the trade premium (as discussed above). You can negotiate with the lender how much of the fee you’d like to pay upfront versus in premium.
With TapCap, your fee is 2% - payable either in fee or trade premium. We give you the choice and we’re 100% transparent about trade premiums.
Due Diligence Requirements
Like the rest of the a7, the due diligence requirements are minimal:
- Certified rent rolls for the last 6 months
- Occupancy history, by quarter, for the last 3 years
- Audited balance sheets and operating statements for the last three years.
- Year-to-date financial statements. May be unaudited, but must be certified.
- Outstanding Mortgage Note (all notes if there are multiple liens on the property).
- HAP contracts, if applicable.
Comparison: a7, IRR and 223(f)
In addition to the a7, there are two other options you should consider.
You likely are familiar with this one already, unless you’ve come to the HUD club via their new construction program (bravo if you made it through). The 223(f) is a standard HUD refinance. The primary difference being that your property’s value will be reassessed, which will largely drive your new loan amount. 223(f)’s take ~6 months and have considerably more due diligence requirements.
The main benefit of choosing the 223(f) route is if you want to cash-out on the value appreciation.
The rates for a 223(f) are the same as for an a7.
In this context the acronym stands for Interest Rate Reduction. An IRR can only be performed by your current lender and it is the most streamlined of the three.
In an IRR transaction, the outstanding GNMA security is prepaid, the HUD insured loan is modified, and a new GNMA security is issued.
We’ll discuss how IRRs work in a future piece, but the short of it is, a GNMA with 10 years of prepayment protection with a 2% rate can be worth more than a 3% GNMA with only 5 years of prepay protection left. This arbitrage allows your lender to pay off the current GNMA and prepayment penalty, set some aside for its own fee, all while lowering your rate.
Your outstanding loan amount and maturity date will not change.
Consider going with an IRR if you don’t want to extend your amortization schedule and/or don’t want additional funds for CapEx/repairs. Keep in mind, since your loan amount doesn’t change, none of the prepayment penalty can be mortgaged - it all must come from the trade premium. This is why an IRR typically doesn’t reduce the rate as far as an a7 can.
|Timeline||30 days||90 days||180 days|
|Loan Amount||Current Principal Balance||UPB + Costs + Prepay+ Repairs/CapEx up to Original Amount||85% of Value, 80% if cashout|
|Interest Rate||Moderate Reduction||High Reduction||Maximum Reduction|
|Out of Pocket Fees||None||Minimal to None||High|
|Cashout||No||Not directly - cash can be put aside for repairs/CapEx||Yes|
|Motivation||Simplest. Moderate Debt Service Reduction.||Maximum Debt Service reduction + cash for repairs/CapEx||Cash out + Minimal Interest Rate|
TapCap A7 App: Because of course we need an app
We’ve partnered with a non-profit HUD lender to deliver absolute transparency and create the most streamlined a7 process ever.
To begin we’ve developed a web app that can automatically stream your loan information, combine it with up to date pricing and generate an actionable a7 term in minutes.
No sign up necessary - a7.tapcap.co