Tax-exempt bonds and 4% tax credits with an FHA-insured loan

Why bonds and 4% credits travel together

There are two kinds of housing credit. The 9% credit comes out of each state’s annual credit ceiling and is awarded competitively. The 4% credit does not: under 26 U.S.C. 42(h)(4), credit attributable to basis financed with tax-exempt bonds that use the state’s private activity bond volume cap needs no allocation from the ceiling at all. The MAP Guide (14.19.4) describes it the same way: tax credit projects “are often financed with the ‘4%’ Tax Credits allocated in conjunction with private activity bond volume cap.”

So a 4% deal has to do two jobs: borrow at the best rate for a long fixed term, and put enough volume-cap bonds into the capital stack to pass the bond test. An FHA-insured loan can do the first; the bonds do the second.

The bond test, before and after 2026

The second route comes from Public Law 119-21, section 70422(b), enacted July 4, 2025. For rehab that counts as a separate new building, the existing building and the rehab are both treated as placed in service when the rehab is. The same section multiplies each state’s per-capita and minimum housing credit ceiling amounts by 1.12 for calendar years beginning after December 31, 2025, which enlarges the 9% pool.

Three other tax points matter to the HUD side of the deal:

• The 4% floor. For buildings placed in service after December 31, 2020, the applicable percentage on a 4% building is at least 4% (42(b)(3)).
• Locking the rate. A bond-financed building can elect to fix its credit percentage in the month the bonds are issued rather than the month it is placed in service (42(b)(1)(A)(ii)(II)).
• The bond’s own set-aside. Volume-cap bonds for apartments must finance a qualified residential rental project: 20% of units at 50% of area median income or 40% at 60%, as the issuer elects (26 U.S.C. 142(d)). The MAP Guide (14.19.1) notes the New York City exception, a 25-60 test, which HUD considers case by case.

The tax analysis belongs to your tax counsel and syndicator. What follows is how HUD treats the financing.

The structure HUD expects to see

The MAP Guide (14.19.4) describes the approach investment banks built for FHA 4% deals:

1. The FHA-insured loan is funded with taxable Ginnie Mae securities, whose yields “at times” come in below long-term tax-exempt bonds and bond-backed multifamily loans.
2. Short-term tax-exempt bonds are issued alongside, secured by cash collateral that initially comes from the FHA lender’s warehouse funds or another source, which is then reimbursed from the Ginnie Mae security proceeds as draws are made.
3. The bonds are retired from the bond collateral account when the project is placed in service.

HUD calls this structure “generally acceptable,” but every transaction is reviewed by Housing field staff and HUD field counsel, and the guide tells underwriters to bring counsel in early.

One rule cannot bend: FHA-insured loan proceeds may not serve as collateral for the bonds, be paid to the bond trustee or be routed to other accounts to help issue them. The MAP Guide calls this a statutory prohibition that may not be waived. Lenders confirm compliance in Section F of the Lender’s Certificate (form HUD-92434M) or the Request for Endorsement (form HUD-92455M), and at closing must certify that a short-term, cash-collateralized 4% bond structure complies with the National Housing Act (19.4.10.3).

221(d)(4) or 223(f)

Both programs take bonds. A 221(d)(4) new construction or substantial rehab deal uses them through the construction period; a 223(f) acquisition or refinance with moderate repairs uses them until the repairs are done. The MAP Guide (8.15.5.1) describes the short-term bonds as maturing “shortly after construction completion (for construction loans) or project repairs” for 223(f) and 223(a)(7). The ratios are the program’s ordinary affordable ones; see LIHTC and HUD for the 90% and 1.11x terms and when a tax credit deal qualifies for them.

Two underwriting rules shape a bond deal’s numbers (MAP 7.17.1):

• Value ignores bond and LIHTC rent restrictions: the appraiser uses market rents and a market cap rate.
• Debt service coverage uses the restricted rents from form HUD-92264-T, whether the tax credit deal uses bonds or not.

What HUD lets you spend

At application the sponsor submits an itemized statement of the estimated costs of issuance, fees and discounts, with the reason for each; the lender’s underwriter checks it against comparable bond deals and adjusts it where needed (8.15.1). The same itemization goes on the Lender’s Certificate at closing (8.15.4).

Deferred fees. Extra discounts or fees can be deferred only if a third party owes them and every party attests in writing that it will not look to the borrower, the property, the loan proceeds, HUD-required reserves or the rents for payment. The borrower may give that third party a note limited to surplus cash (8.15.4.A.4).

The interest rate moves after commitment

HUD processes a bond deal before the bonds are sold, so the underwritten rate “will almost certainly change” (8.15.2). Once the rate is set, HUD issues an amendment to the firm commitment. If there is no time to reprocess a larger loan, the commitment carries a condition: savings that come purely from the gap between the processed rate and the final rate are not spare money for other cost overruns, and go to reducing the mortgage. Savings from finishing construction early are the exception and can offset certifiable overruns elsewhere.

Where the loan rates exceed the bond rate, the spread is held by the bond trustee, and bond counsel must give HUD an opinion that this investment income stays under the trustee’s control and does not flow through the project’s books.

Bond premiums and rebates

Tax-exempt bonds are sometimes sold at a premium (8.15.3). HUD treats the premium as profit of the lender, underwriter or issuer. If any of it reaches the borrower, it is excess investment income that reduces allowable project cost, the borrower cannot benefit from it, and the closing documents must show the amount.

• 223(f): premium income must be transferred to the reserve for replacements.
• Nonprofit borrowers: premium income may cover recognizable cost overruns, with anything left going to the reserve.

At the pre-cost certification conference, negative arbitrage (the bond escrow’s yield against capitalized interest) can be recognized only where there are offsetting savings, and any rebate to the sponsor from the lender, issuer or underwriter reduces certified cost (8.15.6). See cost certification.

Documents HUD reviews at closing

Chapter 19.4.10 applies to every financing that uses a state’s private activity volume cap, whether issued as bonds or as a tax-exempt loan:

• The volume cap financing is disclosed at firm application and written into the firm commitment, which says whether the bonds are taxable or tax-exempt and whether they are cash-collateralized.
• Any bond document with a restrictive covenant, usually the tax regulatory agreement, carries HUD’s rider, which subordinates it, makes HUD requirements control and voids cross-defaults.
• Bond counsel opines on enforceability and tax-exempt status; HUD does not need to be named as relying on it.
• The trust indenture or funding loan agreement includes the language 24 CFR 207.261 requires, so excess bond funds go back to the FHA lender if there is an insurance claim.
• A separate bond note follows HUD’s surplus cash rules, except cash-collateralized bonds, which are exempt.

State or local use restrictions tied to the bonds that go beyond the Internal Revenue Code minimum need the HUD office’s approval, must stay out of the HUD note, mortgage and regulatory agreement, and must end automatically on foreclosure or a deed in lieu unless HUD agrees otherwise in writing (8.15.5.2).

Prepayment on bond deals

The National Housing Act’s five-year bar applies to 223(f) whatever the funding. Beyond that, a mortgage funded by bonds or Ginnie Mae securities may carry a prepayment restriction and penalty acceptable to HUD (11.8.2), and for tax-exempt bond financings the FHA note may use the optional provisions that prohibit prepayment (19.4.10.8). Read the bond documents as well as the note before planning an exit. See HUD prepayment.

Proving the allocation

The firm application on a 4% deal includes evidence of an allocation of private activity bond cap. Because state timing varies, HUD accepts other evidence, such as the bond cap allocator’s written assurance that cap remains available, that an application is in and that an allocation is obtainable in time (14.5). Regional offices have discretion to accept what is customary for the allocating agency.

Qualified state housing finance agencies can also share the insurance risk on affordable loans with FHA through risk sharing, which is a separate program from the MAP lender route described here.