Compared to what’s being offered in the private sector, the rates and terms of the Federal Housing Administration’s (FHA) Sec. 221(d)(4) program for new construction loans are more than attractive. Loan-to-cost ratios can reach up to 83.3 percent; the loan has a 40-year amortization; and the rates currently being offered are in the low- 5 percent range.
Sounds great, right? Here’s the bad news: The fatality rate of new Sec. 221(d)(4) applications is now hovering at about 50 percent. So managing your expectations as you begin the loan approval process is key. The following are five tips from FHA lenders on how to navigate the process effectively and position your deal for approval.
1. HUD Doesn’t Trend Rents.
Even though new construction is inherently forward-looking, the FHA doesn’t see things that way. Many borrowers don’t realize that FHA is only concerned with the here and now when it comes to a project’s feasibility.
2. Invitation Letters Are No Guarantee.
The approval process begins with a third-party market study that determines the feasibility of the project and whether there’s demand. HUD then reviews they study and, if they agree there is demand, they’ll issue an invitation letter. Unfortunately, an invitation letter guarantees little. It’s more akin to entering a race where the odds are about even.
3. Don’t Wait for a Quote.
Pulling together the reports, appraisals, and environmental studies needed for a full application submission is often a race against time. While the (d)(4) program goes up to 83.3 percent loan-to-cost, you still need to make up that other percentage in the capital stack. This is a chicken or egg issue. Many borrowers want to make sure they have a loan quote before going out and raising equity, but this will not do in HUD’s estimation. The agency wants to see the equity on hand.
4. The FHA Doesn’t Negotiate.
Sometimes, there’s a gap between what borrowers request in proceeds and what the FHA is willing to do. But the FHA doesn’t think like a private lender. For instance, if you ask for a $20 million loan, and the FHA comes back with an offer of $19 million, it is what it is and there’s no room for negotiation.
5. FHA Lenders Don’t Like Small Deals.
Many FHA lenders will tell you that the economics of making and servicing a 221(d)(4) loan preclude them from making smaller loans (i.e. anything under $ 4 million).