Loan terms can play a major role in how successful and profitable an investment property is. Lower interest rates can keep the monthly mortgage payments down to leave more cash flow for the investor, and a longer term on a fixed-rate loan can protect them from rate hikes.
Investors with an existing HUD multifamily loan may be able to take advantage of a 223(a)(7) loan to refinance their existing insured mortgage and improve the cash flow of the property. This can allow them to lock in a lower interest rate and reamortize their existing loan to save a significant amount on their mortgage payments.
Here, we discuss what a HUD 223(a)(7) loan is, what it can be used for, and how to get one.
What is a HUD 223(a)(7) loan?
223(a)(7) loans are used to refinance certain HUD-insured debt on multifamily and assisted living properties. Investors typically use these loans to lower their interest rate, increase the amortization, and extend the term on their existing FHA loans.
223(a)(7) loans are nonrecourse and typically provide some of the lowest interest rates and longest terms available to multifamily investors.
What can a 223(a)(7) loan be used for?
Unlike a conventional mortgage, investors are limited in what they can use 223(a)(7) loans for. These loans are limited to covering the cost of paying off existing HUD-insured debt, refinancing costs (including prepayment penalties), certain repairs, and to pay deposits for replacement reserve accounts.
Investors can't use a 223(a)(7) loan to get cash out of their equity or to make improvements to the property. However, there are some critical and noncritical repairs that can be made with the proceeds, subject to certain limitations and a project capital needs assessment.
What loans can be refinanced with a 223(a)(7) loan?
A 223(a)(7) HUD multifamily loan can only be used to refinance certain existing FHA-insured loans. Below are the two most common types of HUD multifamily loans.
A 223(f) loan is a HUD-insured loan for multifamily properties. These are nonrecourse loans with amortization up to 35 years.
221(d)(4) is another type of HUD-insured financing for multifamily properties. These loans are for the ground-up construction of apartment buildings and can be amortized for 40 years after a construction period of up to three years.
223(a)(7) loan terms
223(a)(7) loans fall into terms set by HUD's rules. However, the exact terms of the mortgage loan will depend on the terms of the existing loan as well as the lender. Here's a look at the specifics:
- Loan amount: 100% of refinancing cost.
- Interest rate: Fixed rate subject to market conditions at time of rate lock.
- Minimum debt service coverage ratio (DSCR): 1.11 times for for-profit borrowers; 1.05 times for nonprofit borrowers.
- Term: Up to 12 years beyond the original maturity date, but not to exceed the maximum term allowed under the original loan or 75% of the remaining useful life of the property.
- Prepayment penalty: Typically 10-year protections with two-year lockout period followed by a declining penalty for years 2-10.
- Assumable: Yes, with HUD approval.
- HUD application fee: 0.15% of loan amount.
- Mortgage insurance premium: 0.5% for market-rate housing; 0.35% for affordable housing; 0.25% for green/energy-efficient housing.
Obtaining a 223(a)(7) loan
HUD doesn't provide these loans directly to a borrower. Instead, investors go through an FHA lender. While each lender has their own application and underwriting process, the 223(a)(7) loan was designed to be a streamlined process with minimal hoops to jump through to receive FHA approval compared to other HUD-insured loans.
An appraisal, environmental study, and market study typically isn't necessary as with most commercial real estate loans, mainly because those due diligence items would have already been completed with the original HUD-insured loan.
Once the lender underwrites the loan themselves and provides a firm commitment, the application will be sent to HUD for their review and underwriting. At this point, HUD will make the final decision on approval.
Investors can review HUD's Multifamily Accelerated Processing (MAP) Guide to fully understand the approval guidelines and process before applying. This will ensure they have everything in order that's needed to meet the loan requirements.
The bottom line
Investors can use a 223(a)(7) loan to significantly lower their debt service and increase their cash flow on their multifamily properties with existing indebtedness that's insured by HUD. However, it's important to fully understand all the terms of the new loan and make sure it fits with your long-term plans for the property. This is especially important since it will likely be resetting the clock on a prepayment penalty, which can add a substantial amount to the cost of selling the property.
Whether a 223(a)(7) loan is the right option or not, regularly reviewing refinancing options on an investment property can go a long way in maximizing the return.