Affordable housing loans perform like some of the safest securities available, yet they often carry interest rates as if they were nearly as risky as speculative condominium towers.
Why?
Both the research I have done and a decade of my own experience working in the field suggest to me that one reason affordable housing debt tends to be overpriced is that it is shoehorned into a real estate lending structure designed for market-rate, commercial deals. That made sense when the affordable housing sector was nascent. Now, with an extensive decades-long track record, financing should be brought in line with the actual risk level.
To provide a simple overview of the status quo, when banks originate loans for commercial, market-rate real estate, they have a cost of capital tied to the secured overnight financing rate (SOFR), an interest rate benchmark that reflects the cost banks pay to borrow. The SOFR rate fluctuates, but as of the end of May 2026, it was 3.63 percent. Banks charge borrowers a “spread” on top of SOFR. The spread generally captures the risk, time value, and administrative burden that justify the bank making a loan compared to its next-best investment.
These factors create an appropriate lending space for commercial debt, but affordable housing default rates are much lower, and as a type of asset it performs so differently that this traditional framework is a poor fit. The bottom line: Affordable housing costs far more than it should.
How Does Overpricing Occur?
The idea of overpriced financing is broad. Consider the use of 9 percent, low-income housing tax credit (LIHTC) funds, the single most common form of subsidy for affordable housing development in the U.S. Since 2010, LIHTC, coupled with additional investment, has enabled about 50,000 new affordable rental homes to be built annually. Since LIHTC was adopted, nothing else has catalyzed more subsidized affordable rental housing in the U.S.
I spent years as a real estate developer in California. Throughout that time, I never heard of a project that closed on its tax credits, began construction, and then defaulted on its construction-period loan. It turns out that among the estimated 500,000 units of affordable rental housing built using LIHTC in California since the early 1990s, there has been perhaps just one documented instance of that sort of default.
This remarkably low default rate does not mean affordable housing is risk-free. Rather, it’s a sign that checks and balances protect the construction lender—and that failures that do occur typically do not happen during construction.
What Is the Cost of Overpriced Debt?
At present, affordable housing construction loans are typically priced at 200–250 basis points, or 2–2.5 percent, above SOFR, Alice Talcott, a California-based affordable housing expert, tells Shelterforce. If loans were priced in line with actual risk, I estimate this spread would be 90–170 basis points. In other words, loans cost between 30 and 160 basis points above what actual default rates suggest they should cost.
For those not intimately familiar with affordable housing costs, this difference may sound small, but it adds up to hundreds of thousands—or even millions—of dollars per multifamily apartment building. Sector-wide, a reduction in interest costs of this magnitude would save hundreds of millions or even billions of dollars, stretching public subsidies further and enabling private investment to support the construction of more affordable homes.
Why should rates be lower than they are? The default rates on loans for LIHTC projects are lower than those of AA-rated corporate bonds, but their interest rates are about 150 basis points (1.5 percent) higher.
| Asset Class | Default Rate (%) | Estimated Interest Rate (%) |
| AA Corporate Bonds | 0.75 (10-year period) | 4.93 (as of June 1) |
| Construction Loans on LIHTC Projects | 0.47 | 6.1–6.7 (per Alice Talcott estimate for Shelterforce) |
| Market-Rate Commercial Construction Loans | 1.03 | 7.15–7.75 (3.57–4.17 above SOFR in 2025) |
Estimating the exact interest rates for construction loans is difficult because rates vary on a project-by-project basis. The estimate for construction loans on the LIHTC projects listed above relies on data provided to Shelterforce by Talcott.
The reason affordable housing can’t achieve lower interest rate spreads is the lending framework it operates within and its source of capital. That framework decreases the value of affordable housing loans relative to other investments in the economy. If affordable housing debt broke out of this constraint, it could find itself in a more competitively priced market where interest rates would be appropriately risk-adjusted and lower than they currently are.
Why Affordable Housing Loan Default Rates Are Low
In a typical market-rate construction loan, the lender underwrites a couple of primary “known unknowns”—namely, execution risk and exit risk. Execution risk is the risk that a project will not be completed as expected. Exit risk is the risk that the lender will be unable to exit a deal at the time and/or for the value they find acceptable. The checks and balances in place for affordable housing financing mitigate or eliminate these risks.
Addressing Execution Risks
Affordable housing deals involve many more partners than market-rate deals because of the number of funders required. Many projects have more than six private and public funders.
When challenges inevitably arise, they aren’t resolved only by the developer; they are resolved by an entire army: local government, the state, the equity investor, the subordinate lender, and others. The multilayered nature of the affordable housing capital stack creates a collective backstop that reduces financial exposure and the potential for any default. It isn’t that these projects bear no risk; rather, this collective army surrounds and protects the construction lender.
The developer sponsors the project and assumes much of the risk. They may self-subsidize a project that incurs a cost overrun, providing a significant layer of protection for the senior construction lender. The developer fee is one such shock absorber. Mistakes happen, and any project is just one big mistake from a $2 million cost overrun. In affordable housing, if that happens, the developer can—and may be required to—contribute their earned, upfront developer fee back into the project to cover the unanticipated gap, taking their fee instead as a priority payment from future cash flow (a deferred developer fee). Given that the cash flow waterfall in a market-rate deal is fully accounted for, this mechanism does not typically exist in the market-rate world.
More broadly, public and private partners subject drawings, financial projections, and the developer’s ability to execute the project to rigorous scrutiny. This scrutiny occurs throughout applications, credit committees, public hearings, and ongoing oversight. As a result, potential challenges are often caught and managed early on.
In addition, the presence of municipal partners who contribute financially to a project gives them significant political and financial skin in the game. This creates a form of troubleshooting equity, incentivizing them to help resolve permitting delays or construction hurdles that might otherwise sink a market-rate project. They may even make an additional last-minute financial contribution to address a cost overrun.
Finally, in a 9 percent LIHTC deal, the tax credit investor, as the project’s limited partner (LP), provides the ultimate backstop. By the time the construction loan closes, the LP has committed to paying up-front cash so they can claim tax credit benefits once the project is completed. This incentive aligns the equity investor’s goal with the lender’s goal. It means the LP will exercise their rights to step in and cure the construction loan before the lender files a notice of default. It is not only their legal responsibility to do so but also a doubly effective financial incentive.
Addressing Exit Risk
While execution risks are greatly reduced, perhaps the most significant risk mitigator is the nature of the permanent loan take-out, which reduces exit risk. The permanent loan take-out is when a—typically—30-year mortgage comes in at the completion of construction and lease-up to repay the roughly 36-month construction loan. It’s essentially a planned refinancing, and in a market-rate deal, the construction lender lives in a state of anxiety about this refinance hurdle. If the market turns—whether interest rates spike, cap rates expand, or rental income drops significantly—the project’s value may decrease, leaving a gap between the construction loan balance and what a permanent lender can provide.
For LIHTC projects, however, tax credit investors require that a permanent loan be secured before the construction loan closes. These are not “maybe” commitments; they are forward-committed permanent loans with mandated rate locks. This effectively fixes the “exit price” of the asset before the first shovel hits the ground. The borrower must pay a substantial fee for the rate lock, and it’s a key factor that protects against exit risk.
Another big difference mitigating the exit risk is the leasing environment. An affordable housing developer operates in a high-demand market given the shortage of available affordable housing units.
Waitlists often stretch into the thousands, and affordable housing projects typically have no problem achieving the lease-up rate required to close on refinancing. By contrast, for a market-rate developer, there is much greater leasing uncertainty. This is why it is not unusual for a new market-rate apartment complex to offer one to three months of free rent as a lease-up sweetener.
Mind the Gap
Lenders underwrite against various risks that are significantly mitigated in affordable housing. Even among market-rate projects, though, those individual factors may not be the primary cause of default.
A study by the Federal Deposit Insurance Corporation found that the main cause of default isn’t a specific underwriting criterion that indicates high risk; it’s when market conditions worsen while the loan remains outstanding. If debt pricing is based on risk, then what lenders are really bracing for and hedging against are market collapses like those that occurred during the Great Recession.
Here, affordable housing demonstrates considerable resilience. Data shows that affordable housing loans continue to carry low risk even during downturns, unlike market-rate commercial construction loans. For example, during the Great Recession’s 2009 peak, delinquency on market-rate construction loans was 16.6 percent, with 5.2 percent in foreclosure.
In contrast, a 2025 report on 36,400 affordable housing properties developed since the 1986 tax reform found that 2.5 percent of loans have been distressed and 0.47 percent have been foreclosed. This isn’t a low-end figure; it’s the cumulative debt outcome for affordable housing since the LIHTC program was adopted.
This shows that the financial safeguards in place for affordable housing loans are working and that affordable housing construction debt is highly stable. At their core, affordable housing and market-rate construction debt behave so differently across the economic cycle that they are wholly distinctive asset classes.
From Awareness to Market Adjustment
If affordable housing construction loans are less risky than market-rate construction loans, they should carry commensurately lower interest rates. But banks are constrained by the financing structure they operate within from issuing construction loans. Instead, outsiders must build and scale alternative private and public construction loan solutions.
Private Solutions
Accessing bond markets could help secure an alternative, lower-cost source of capital. BRIDGE Housing, a large West Coast nonprofit affordable housing developer, offers a valuable example. BRIDGE has used its corporate strength and real estate portfolio to obtain an investment-grade bond rating, issue bonds, and use them in lieu of construction loans. For a pilot project known as hollywoodHUB in Portland, Oregon, this method reduced construction costs by $4 million.
If smaller affordable housing developers pooled their resources, they might be able to do something similar. Member organizations could borrow bond proceeds as a type of construction loan and pay an interest rate that both undercuts lender rates and repays bond buyers.
The affordable housing industry has done something similar before. In 2004, Housing Partnership Network, an organization representing more than 100 housing and community development organizations, created the Housing Partnership Insurance Exchange, which allowed affordable housing developers and owners to obtain comprehensive insurance coverage outside the volatile traditional commercial insurance market.
Members of this exchange operate their own insurance mechanism, which improves financial stability and transparency. This insurance exchange is still used today, and the collaborative effort that brought it together could also be applied to construction loan financing.
Public Solutions
Public agencies may be mandated to pursue solutions that reduce the cost of new affordable housing. After all, if the cost to build new affordable housing were to decrease, government agencies could offer each project less subsidy, enabling the construction of more affordable housing.
One public agency–led solution that capitalizes on the low risk of LIHTC construction loans could be to create a revolving construction loan fund. A revolving loan fund is a self-replenishing pool of capital in which principal and interest from old loans are recycled to issue new loans. Construction loans often mature within 36 months, creating significant turnover and opportunity for a revolving fund to reduce costs for many projects.
Something like this could be implemented at any level, from local to federal. For example, the Federal Home Loan Bank (FHLB) could offer it nationally. The FHLB is legally required to reinvest a portion of its profits into affordable housing. Those profits could be used to pilot a revolving loan concept, reducing the cost of affordable housing construction and helping model the concept for local government agencies to adopt. If it proved sustainable, a city or regional agency might establish a revolving loan fund to increase support for affordable housing within their jurisdictions.
What Now?
Decades of results are telling. Affordable housing construction loans are overpriced, making it more expensive to build new affordable housing than it ought to be.
If the current financing structure for affordable housing construction debt is replaced, what should the design of its replacement be? One that mirrors another industry for simplicity, or one that saves the most money for projects?
Various feasible models could emerge beyond what we have outlined here. A novel structure might be bespoke and costly at first, but it will eventually be tested and practiced, and efficiencies will emerge during replication.
With financing, many of the rules have emerged by convention rather than from a careful assessment of actual default risk. Financial innovations have occurred countless times and routinely occur in the world of corporate finance. It is time to do more in mission-aligned spaces to make the construction of affordable housing more affordable.
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