The rapid rise of interest rates in 2022 resulted in numerous recalculations for every real estate investor. The impact is particularly intense on investors who opted for bank loans with a 5-year, 7-year or 10-year term a few years ago who must refinance in a rising interest rate environment. A side effect of these market conditions is that they highlight the sometimes-overlooked advantages of FHA/HUD’s loans.
“If you’re taking out a new loan now, we can work through your options and structure them to your advantage for future market conditions,” says Scott Thurman, Head of Production, FHA Healthcare for Greystone. “If you have to refinance now, we can also work with you to mitigate the impact of higher rates.”
4 FHA Loan Advantages
HUD-insured financing offers several benefits to borrowers that became more apparent as interest rates rose at a fast clip in 2022.
- No maturity risk. Borrowers typically lock in a rate on a HUD loan for a fully amortized 25-year, 30-year or 35-year term, so there’s no requirement to refinance during the full term. Bank loan borrowers typically lock in a rate for a 5-year, 7-year or 10-year term, based on a 30-year amortization period. That forces borrowers to refinance when their loan matures even in an unfavorable interest rate market. For example, a typical rate on a $10 million term loan 10 years ago was 3.75%. Refinancing now into a loan with that same term would require a mortgage rate of above 7.00%.
- Negotiable prepayment premium terms. When you lock in your interest rate, you’ll also agree to a prepayment premium. “But the prepayment premium is negotiable to meet your needs, so it can be structured for flexibility to take advantage of expedited refinancing or an interest rate reduction in the future,” says Thurman. “It can also be structured to reduce the prepayment premium by year five of the loan and yet still with a favorable rate to most term loans.”
- Assumable loan. HUD-insured loans are assumable, which could enhance the value of your property when you decide to sell. “How much value a buyer attributes to this depends on how long the loan has been in place, your interest rate and how much equity the buyer might need to bring to the transaction,” says Thurman.
- HUD rates are lower. While HUD-insured loans require mortgage insurance, their lower interest rates generally offset that additional cost. Recently (as of 12/9/22), rates on term loans ranged from 7.0% to 7.5%, while FHA loans were at 5.12%.
Refinancing into a HUD Loan
HUD-insured loans are designed for long-term investment, but it may be time for borrowers to reconsider that timeline, Thurman notes.
“Even a 3-to-5-year window could work with a HUD loan if it’s structured to provide the flexibility to reduce the prepayment premium and allow for interest rate reductions over time,” he says.
Besides flexibility, HUD-insured loan interest rates are typically lower than term rates. As an example, refinancing a $10 million loan into HUD financing would considerably reduce costs.
“At today’s rates, refinancing into a new loan with the same loan term, would increase principal and interest payments by $68,500 a year for the 10-year term and over $168,700 a year for the 5-year term,” says Thurman. “That is an increase of 12.3% to over 28% of the payment for the original loan. Even at today’s higher interest rates, using a HUD-insured loan to refinance a term loan coming due would only increase debt service by 5% in the 5-year example and actually lower debt service in the 10-year example, including the mortgage insurance premium.”
In today’s economy, with inflation increasing expenses, being forced to refinance could be very challenging. A HUD-insured loan could mitigate some of that financial pressure while preserving flexibility and eliminating maturity risk, Thurman says.