Secondary financing behind a HUD loan: what is allowed, and on what terms

The first-lien rule and its exceptions

An FHA-insured apartment loan has to be the first lien on the property (MAP 3.1.17). The regulation behind that, 24 CFR 200.71, lets the property carry an inferior lien only on HUD’s terms, and only where the junior lien is held by a government instrumentality, is tied to a 223(d) operating loss loan, a 241 supplemental loan or a 223(f) purchase or refinance, or is otherwise approved by HUD. The mortgage itself contains a covenant (24 CFR 200.85) that any approved junior lien will be repaid only from surplus cash or residual receipts, never from mortgage proceeds.

In practice that leaves a handful of kinds of subordinate money, each with its own rules:

Rules every second loan follows

Whatever the source, MAP chapter 8.7 attaches the same core conditions:

• Surplus cash only, and only 75% of it. Required payments of principal and interest on all secondary debt combined may not exceed 75% of available surplus cash. The MAP Guide gives the exact clause to put in the note. Money from outside the property can also repay the second. What counts as surplus cash is set by the regulatory agreement; the surplus cash guide explains the calculation.
• No earlier maturity. A subordinate loan may not mature before the HUD-insured first mortgage. For public debt only, HUD’s underwriter can accept a shorter term case by case when another program, such as HOME or the National Housing Trust Fund, requires it and the risk is offset by things like low leverage, below-market rents or higher coverage.
• No foreclosure threat. The junior lender’s documents may not contain a cross-default or a right of foreclosure before the FHA loan ends.
• Listed on the application. Every subordinate loan appears in the sources of funds on form HUD-92264-A.

Public soft debt

HOME funds, the Federal Home Loan Banks’ Affordable Housing Program, grants and other federal, state, local or quasi-public loans are treated the most generously (MAP 8.7.1):

• They can replace up to 100% of the program’s required equity and can also pay for costs HUD will not put in the mortgage, so the HUD loan, the equity and the public money together can exceed 100% of total project cost. The funder has to certify that those non-mortgageable costs are reasonable and necessary.
• They cannot stand in for tax credit equity.
• The public subordination agreement (HUD-92420M) makes the junior loan assumable when the property is transferred with the HUD loan in place, terminates it if HUD takes title by deed in lieu, and requires the junior lender to extend the loan if surplus cash is not enough to repay it when due (MAP 8.7.6).
• Restrictive covenants in the public loan normally have to end if the HUD loan is foreclosed. HOME-funded loans are the exception: HUD lets their covenants survive foreclosure, and similar state programs can be considered case by case.
• Both the junior lien and the HUD loan documents must be recorded by the day of closing, and the junior loan cannot fund until closing.

Private seconds on a 223(f)

On a 223(f) purchase or refinance, private secondary financing can cover mortgageable and non-mortgageable costs up to the gap between the HUD loan’s loan-to-value and 92.5% of fair market value (MAP 3.7.17, 8.7.2). It can be secured by a lien on the property within that 92.5%.

A worked illustration, using the current 87% market-rate limit from Mortgagee Letter 2025-03: on a property valued at $20,000,000, the HUD loan can be at most $17,400,000, so a private second can add at most $1,100,000 (5.5% of value) before total debt reaches $18,500,000. That arithmetic is ours; HUD publishes only the 92.5% limit. On a deal sized below 87% by debt service coverage, the room for a second is larger, but the second’s own payments still come only from surplus cash.

Two exceptions to the 92.5% cap:

• When the private second sits alongside government secondary financing, the public loan plus the HUD first and the private second together may exceed the property’s value.
• On LIHTC transactions the 92.5% test does not apply at all (see the LIHTC section below).

Mezzanine debt

HUD defines mezzanine financing as a subordinate loan usually secured by a pledge of ownership interests rather than a lien on the real estate. The MAP Guide (8.7.2.D-E) allows it on these terms:

• Full disclosure of the terms and written HUD approval. Mezzanine debt left over from an earlier financing is subject to the same rules.
• Payments only from surplus cash, and no maturity before the FHA loan.
• An interest rate consistent with the market for mezzanine debt, not so high that it jeopardizes ownership stability or cannot reasonably be paid from surplus cash. HUD must approve the interest as reasonable.
• No enforcement against the real estate or the borrower entity during the loan, and no action that would trigger a transfer of physical assets without HUD approval. If the mezzanine lender takes over ownership interests after a default, the transfer goes through HUD’s TPA process, the same review used for an assumption.

Exceptions to any of this need a written HUD waiver on form HUD-2.

Construction loans: seller notes only

Private secondary financing is not permitted on 221(d)(4) or any other new construction or substantial rehabilitation first mortgage (MAP 8.7.3). The only private exception is a seller take-back note, and it has to clear every one of these tests:

1. The FHA loan is less than 50% of mortgageable replacement cost (80% on a tax credit application).
2. The sale is arm’s length, or, with an identity of interest, the land or building is sold for no more than its as-is value.
3. The note is paid from surplus cash within the 75% cumulative cap, is not recorded or secured by the property (except on LIHTC deals), has no foreclosure provision that threatens the first mortgage, re-subordinates automatically on any refinance of the first, and has no balloon or maturity before the HUD loan.

Public soft debt remains available on construction deals under the rules above. On a 223(a)(7) refinance, secondary financing follows the rules of the program being refinanced, but it cannot be used, directly or indirectly, to take equity out or fund a transfer of physical assets (MAP 8.7.4).

LIHTC transactions

For tax credit deals, HUD drops the loan-to-value limit on secondary debt entirely, whether public or private, because debt limits can shrink tax credit basis (MAP 14.11). Debt can exceed value. The conditions that remain:

• Payments on all secondary debt, together, from no more than 75% of annual surplus cash or the proceeds of a sale or refinance.
• The FHA loan plus all public and private secondary debt no more than 100% of total mortgageable and non-mortgageable project cost, tested against the HUD underwriter’s sources and uses. Public loans are left out of that 100% test.
• Maturity at or after the first mortgage (public debt exceptions as above), and a reasonable expectation that the debt can be paid off over its term from 75% of surplus cash.
• HUD’s surplus cash note with simple interest. HUD will allow compounding if the lender shows cash flow is strong enough that accruing interest will not undermine the project.
• Private debt up to 100% of total project cost may be secured by the project under every program, with automatic re-subordination on any refinance of the first.

Tax credit equity bridge loans are treated separately (MAP 8.7.8, 14.16), and a deferred developer fee is not counted as secondary debt for these limits. The LIHTC guide covers how HUD loans and tax credits fit together.

The note forms

The form depends on the borrower and the deal (MAP 8.7.7):

Form	Used for
HUD-92223M, Surplus Cash Note	Profit-motivated borrowers; also the standard for LIHTC secondary debt
HUD-91710M, Residual Receipts Note	Nonprofit borrowers
HUD-91712M, Residual Receipts Note	Limited dividend borrowers
HUD-92908M, Residual Receipts Note	Borrowers whose distributions are restricted by a residual receipts rider

Common features: interest does not compound (subject to the LIHTC exception), payments from project income or assets only as the regulatory agreement allows, and unauthorized payments must be returned to the project. Under the surplus cash note, prepaying from sources outside the project does not need HUD approval. The residual receipts notes add that prepayments can be made only after final endorsement and the end of a fiscal period, and that the note cannot be sold or pledged.