Credit enhancement programs add security to private lenders. Issuers of credit enhancements – often, municipalities – provide funds or assurance to cover losses in the event of borrow default. Credit enhancements require a source of funding to support the guarantee that is extended to lenders. Grant, ratepayer, bond, and philanthropic funds could be used to capitalize these efforts.
In the case of a loan guarantee, one option is to implement through an institution with a very strong credit rating, such as a city or state treasury department or a state housing finance agency. For any credit enhancement program to succeed, a partnership with a financial institution (such as a national or regional bank, or a CDFI) is required.
Credit enhancements can take a variety of forms:
Loan loss reserves: Specify that a specific amount of capital (e.g., 10 percent of the balance of a pool of loans) is held in escrow by a local government or advanced to a lender upfront to securitize the loan.
Interest rate buy-downs: Deliver a single payment to a lender at the beginning of a loan term as security, and is retained by the lender at the end of the loan term.
Loan guarantees: Issued by a creditworthy institution such as the federal, state or local government.