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HUD Refinance223(f) · 232 · 223(a)(7)

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Loan structure

Prepayment on FHA-Insured Loans: The Ten-Year Step-Down

A 35-year loan with ten years of call protection is a different instrument from a ten-year loan. If the hold period is shorter than the protection, the structure is working against the plan.

Reviewed October 13, 2026  ·  All primary sources

FHA-insured loans carry prepayment protection, typically running ten years. The most common structure is a step-down beginning at 10% of the outstanding balance in year one and declining one percentage point annually — 10, 9, 8, and so on — reaching zero after year ten. Some lenders offer a lockout period followed by a shorter step-down, and alternative structures are negotiable depending on market conditions.

After the protection burns off, the loan is openly prepayable. There is no yield maintenance and no defeasance for the remaining twenty-five years of a 35-year loan. That is a meaningful difference from much of the agency and CMBS market, and it is rarely highlighted.

Why the structure exists

FHA insurance exists to support long-term, stable financing of housing and healthcare facilities. The insurance fund's economics depend on loans staying outstanding long enough to earn the premium against the risk assumed. Call protection aligns the borrower's behavior with that, and it supports the price of the loan in the GNMA securities market where it is funded.

Matching the structure to the hold

This is where the analysis usually goes wrong, and it goes wrong in a predictable way: the sponsor evaluates a 35-year loan on its rate and then operates the asset on a five-year plan.

Prepayment cost by exit year, typical step-down
Exit yearPenalty on balanceComment
Year 38%Severe. Usually disqualifying for a sale.
Year 56%Material drag on proceeds.
Year 83%Often absorbable.
Year 11+0%Open.

Illustrative, based on the common 10%-declining-1%-annually structure. Actual terms are set at commitment and vary by lender.

On a $20 million loan, a year-five exit at 6% is $1.2 million off net proceeds. That is not a rounding item and it is knowable at closing.

The assumption alternative

The structural answer to a mid-term exit is usually not to prepay. It is to sell the property with the loan in place. FHA loans are fully assumable with HUD and lender approval on payment of 0.05% to HUD, and if the coupon is below market the debt is an asset to the buyer rather than an obstacle.

This reframes the whole question. A sponsor who might exit in year six is not necessarily mismatched with a ten-year protection period — they are relying on assumption rather than prepayment as the exit mechanic. What they need to confirm is that the loan documents and HUD's transfer process accommodate the kind of buyer they expect, and that the facility or property type does not complicate approval. On healthcare, where the transferee's operator qualifications and licensure are reviewed, assumption is a longer process than on an apartment building.

Two provisions that interact with this

The rate lock deposit. Commonly 0.50% of the loan amount, refunded at closing. It is not a prepayment item but it is the first real money at risk in the transaction, and it is posted before closing certainty.

Secondary financing. Permitted as a surplus cash note, with combined loan-to-value generally capped at 92.5% unless the subordinate source is governmental. Form HUD-92223M, the surplus cash note, caps payments at 75% of surplus cash — and that cap is an aggregate across all subordinate debt, not a per-note limit. Sponsors layering more than one subordinate note sometimes miss this.

Questions to ask at term sheet

  • What exactly is the prepayment structure — lockout, step-down, or a combination, and over how many years?
  • What alternatives will this lender offer, and what does each cost in coupon?
  • Is there any prepayment permitted without penalty from condemnation, casualty or a partial release?
  • What is the rate lock deposit and under what circumstances is it not refunded?
  • What does the assumption process look like for the kind of buyer we expect, and how long does HUD approval take in practice?

The last question is the one most sponsors skip and most often need.

Primary sources for this article

Figures stated as current are current as of October 13, 2026. HUD revises mortgagee letters and handbooks frequently; where a provision is a draft rather than operative guidance we say so on the page. This is general information, not legal, tax or financial advice, and not a commitment to lend.

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The program terms summarized here are drawn from HUD mortgagee letters, Federal Register notices, the MAP Guide (Handbook 4430.G) and the Section 232 Handbook (4232.1), each cited on the page where it is used. HUD revises these materials frequently, sometimes without notice, and provisions may be superseded between our review dates. Figures stated as current are current as of October 13, 2026. Loan sizing is always the lowest of several statutory and underwriting tests applied to a specific property, and no figure on this site should be read as the amount any particular project can obtain.

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