LIHTC construction loans: how they're sized, structured and repaid
A LIHTC construction loan funds the building while the investor's equity arrives in installments. The lender sizes it to the full gap between cost and the equity paid at closing, then gets repaid at completion and conversion from later equity installments and the permanent loan. On 4% deals the construction loan is usually also how the tax-exempt bonds get placed, either by the bank buying the bonds directly or by cash-collateralizing short-term bonds with a taxable loan.
A tax credit construction loan looks like any construction loan in the field: a draw schedule, an inspecting engineer, retainage, a budget with contingency. What differs is what pays it off. A market-rate construction loan is repaid by a refinance or sale. A LIHTC construction loan is repaid by two promises made at closing: the investor’s commitment to pay its remaining equity installments, and the permanent lender’s commitment to fund at conversion.
What the lender is really underwriting
| Risk | What the construction lender checks |
|---|---|
| Completion | Contractor’s experience and bonding, guaranteed maximum price contract, developer’s track record and liquidity |
| Equity performance | The limited partnership agreement: installment amounts, the conditions to each one, adjusters if credits come in lower or late |
| Takeout | The permanent loan’s forward commitment: rate lock, maximum amount, the occupancy and coverage tests at conversion, expiration date |
| Credit delivery | Allocation or bond cap award, carryover allocation for 9% deals, the 10% test and placed-in-service deadline |
| Lease-up | Market study absorption at restricted rents, waiting lists, any rental assistance contract |
The lender’s worry is not whether the building is worth the loan. It’s whether each condition to the equity and the permanent loan will be met in time.
How the loan is sized
Construction lenders typically size to the total development cost less the sources that fund before or during construction, then test that number against the sources available to repay it.
Sizing: construction loan = TDC - equity paid at closing and during construction - soft loans funded during construction - deferred fee.
Repayment test: construction loan <= later equity installments + permanent loan at conversion + any soft money that funds at completion.
Using the worked 4% deal in the financing guide ($48,000,000 TDC, $17,054,294 equity, $19,100,000 permanent loan, $9,345,706 of soft funds, $2,500,000 deferred fee), suppose the investor pays 20% of its equity at closing, the soft lenders fund $6,000,000 during construction and the rest at completion, and the developer contributes nothing in cash.
| Amount | |
|---|---|
| TDC | $48,000,000 |
| Less equity at closing (20%) | ($3,410,859) |
| Less soft funds during construction | ($6,000,000) |
| Less deferred fee (never funded in cash) | ($2,500,000) |
| Construction loan needed | $36,089,141 |
| Repaid by: remaining equity (80%) | $13,643,435 |
| Repaid by: permanent loan | $19,100,000 |
| Repaid by: soft funds at completion | $3,345,706 |
| Total takeout | $36,089,141 |
The pay-in schedule is the lever. Push more equity to closing and the construction loan shrinks, but investors price early pay-in lower because their money is at risk longer. Push equity later and the construction loan (or a bridge loan) grows. Model the trade in the equity bridge calculator.
The 4% deal: bonds and the construction loan are the same decision
For a 4% building to get credits without a 9% allocation, tax-exempt private activity bonds subject to the state’s volume cap must finance at least 50% of aggregate basis (building plus land), or at least 25% if one or more of those bonds, from an issue dated after December 31, 2025, together finance at least 5% of that basis; the 25% test applies to buildings placed in service in taxable years beginning after December 31, 2025, and the 50% test still applies as an alternative (IRC 42(h)(4)(B); Pub. L. 119-21 sec. 70422(b)). There are three common ways to place those bonds during construction:
| Structure | How it works | When it fits |
|---|---|---|
| Direct purchase by the construction bank | The bank buys the bonds (often as drawdown bonds funded as costs are incurred). The bond is the construction loan. At conversion, the bonds are partly paid down and the remainder becomes, or is replaced by, the permanent loan. | Bank wants tax-exempt yield and CRA credit; deal is large enough to justify the documents |
| Cash-collateralized short-term bonds | Bonds are sold publicly, short-term, and the proceeds sit in escrow. A taxable construction loan funds the work, and as it funds, an equal amount of bond proceeds is released, so the bonds are always fully secured by cash or the loan. The bonds are redeemed at or before conversion. | Permanent loan is a Fannie, Freddie or FHA execution and the bonds are needed only to pass the test |
| Construction-to-permanent tax-exempt loan | A single lender (Freddie Mac’s TEL forward, an FHA 221(d)(4), or a bank) is funded through a governmental lender note or bonds through both periods. | Sponsor wants one lender and one rate lock |
Two statutory details matter for short-term bonds. Principal payments on the bond-financed loan must be applied within a reasonable period to redeem bonds, or the financing refunded under section 146(i)(6), for the credit to stay outside the ceiling (42(h)(4)(A)(ii)). And the bonds must actually finance basis, so bond counsel tracks which costs bond proceeds paid for. See tax-exempt bond financing for 4% deals.
Guarantees and covenants
Expect most of these on a bank construction loan, and a parallel set in the partnership agreement running to the investor:
- Completion guarantee from the developer and a creditworthy parent.
- Cost-overrun guarantee, usually backed by the deferred fee first.
- Repayment or payment guarantee for some or all of the loan until conversion.
- Environmental indemnity, always full recourse.
- Net worth and liquidity covenants on the guarantor, tested at least annually.
- Interest reserve in the budget, sized to the projected draw curve at a stressed rate.
Rate and term
Most bank construction loans float over SOFR with a floor and an extension option tied to lease-up milestones. On a fixed-rate permanent forward, the developer still carries floating-rate risk during construction, so the budget’s interest reserve should be run at a higher rate than today’s. The New York Fed publishes SOFR daily (NY Fed reference rates). Nothing on this page is a rate quote.
Federal requirements that ride along
- Davis-Bacon wages apply when certain federal funds are in the deal: HOME-assisted projects with 12 or more HOME units, FHA-insured construction such as 221(d)(4), and project-based voucher contracts covering 9 or more units are the common triggers. Wage determinations are on SAM.gov.
- Environmental review under 24 CFR Part 58 or 50 applies when HUD funds are involved. No HUD dollars may be committed, and certain choice-limiting actions are restricted, until the review clears.
- FHA programs bring their own construction process: a 221(d)(4) loan funds construction and converts to a permanent loan of up to 40 years after completion in a single close, with mortgage insurance premiums a uniform 25 basis points for FHA multifamily applications submitted or amended on or after October 1, 2025 (90 FR 45789).
Conversion: the day the construction loan goes away
Conversion happens when the property meets the permanent lender’s tests, typically a period of sustained occupancy and debt service coverage at actual rents, with the final cost certification and often the Forms 8609 in hand or on the way. Common reasons conversion slips:
- Lease-up slower than the market study, often because income verification takes longer than a market-rate application.
- Utility allowances set higher than budgeted, which lowers net rent and coverage. See utility allowances.
- The forward commitment expiring before stabilization. Watch extension fees and the outside date.
Bring the construction budget, draw schedule and equity letter of intent to the Janover Capital desk for a sizing check before the bank term sheet is signed.
Questions people ask
Are LIHTC construction loans recourse?
Usually, in substance. Even when the note is nominally non-recourse, the developer and its parent sign completion, cost-overrun and often repayment guarantees until conversion. HUD's 221(d)(4) program is the main exception, since it is a single-close, non-recourse construction-to-permanent loan insured by FHA.
Is construction loan interest included in eligible basis?
Interest during construction is generally capitalized into the cost of the building and so can be part of eligible basis. Permanent financing fees cannot. Allocation between the two is a common audit point, so the cost certification should show how interest after placed-in-service was treated.
What is the typical term of a LIHTC construction loan?
Long enough to build, lease up and convert, which commonly means construction plus a lease-up period, with extension options. The term has to be at least as long as the investor's last pre-conversion installment date and the permanent lender's forward commitment window.
Can the construction lender also be the equity investor?
Yes, and banks often prefer it. A bank that invests in the credits through its own fund or a syndicator's fund often provides the construction loan too, and its CRA team may price both together.