8.7.3 Private Source – New Construction/Substantial Rehab

A. Private secondary financing is not permitted under Section 221(d)(4) or other new construction/substantial rehabilitation first mortgage programs. The only exception to this consideration is Seller-financed secondary debt (aka seller take-back note). The Seller-financed secondary debt must meet the follow criteria:

1. The FHA loan to replacement cost ratio is less than 50% (80% loan ratio for tax credit applications) of mortgageable cost; and

2. The Seller financed secondary debt is either:

   • An arms-length transaction; or

   • It involves an identity of interest transaction and the selling price of the land or building is not greater than the property’s “as is” value.”

3. Seller-financed secondary debt must also meet all of the following:

   • It is an inferior cash flow debt, such that cumulative payments for that and any other subordinate debt must not exceed 75% of surplus cash, if available.

• It is documented in a promissory note that is not recorded and not secured with a lien against the property; this prohibition on a lien does not apply to LIHTC transactions (see Chapter 14).

• It does not contain any provision of foreclosure that would threaten the first mortgage.

• It is subject to automatic re-subordination in any subsequent refinancing of the first mortgage; and

• The subordinate debt does not have a balloon payment or maturity prior to maturity of the FHAinsured first mortgage.