Directing Principal Forgiveness to Communities That Need It Most
Access to clean, safe water is a fundamental necessity, yet many under-resourced communities face significant financial barriers to upgrading essential water infrastructure. State Revolving Fund (SRF) programs play a vital role in addressing this challenge by providing favorable financial assistance, particularly to state-designated disadvantaged communities (DACs). A key component of this support is additional subsidies, often in the form of principal forgiveness (PF) - a mechanism that allows a portion of a loan to be waived, reducing the financial burden on recipients. Since many states prefer to distribute additional subsidies through PF, we will use this term broadly to encompass all forms of additional subsidies, including grants or other financial assistance methods states may employ.
Given the significant opportunity within the SRFs to support state-defined DACs through PF, it is essential to understand the key policy decisions states make that influence how these funds reach the communities most in need. To provide background on the PF-related elements, this blog explores three key policies that shape PF distribution in state SRF programs:
The amount of base funding allocated as PF to state-defined DACs (also referred to as DAC PF);
The establishment of limits or “caps” on the amount of PF awarded; and
The prioritization of projects that benefit state-defined DACs.
For a deeper dive into how states navigate these policy decisions and their impact on PF distribution, check out our Brief on PF policies.
1. Amount of base funding allocated as principal forgiveness to DACs (DAC PF)
The federal Safe Drinking Water Act mandates that states allocate a portion of their base capitalization grants as PF to DACs. In recent years, Congress has required states to distribute between 12–35% of their base capitalization grants as additional subsidies, such as PF, to state-defined DACs (see 42 USC §300j–12(d)(2)). In addition to this required allocation, states have the discretion to provide an additional 14% in discretionary PF to any eligible applicant, offering flexibility in how they structure their funding strategies.
Policy Considerations
When determining PF allocations, states face a critical policy tradeoff: prioritizing immediate financial relief for state-defined DACs versus preserving the revolving nature of the fund by issuing more loans instead of subsidies. While directing more PF to DACs can provide essential assistance, it may limit future loan availability unless the state uses alternative funding mechanisms. One strategy to expand PF capacity without reducing loan funds is leveraging SRF programs through bond issuance. This approach allows states to increase the total funding available for loans while ensuring that funds continue to revolve back into the program. By using a larger portion of new base grants for PF, states can increase additional subsidies while maintaining the long-term sustainability of the fund.
Recommendations
Maximize Allocations: States with communities experiencing high levels of need should strive to allocate the maximum allowable DAC PF (35%) under the base SRF program. Additionally, leveraging funds through strategies like bond issuance can help expand the overall capacity of the state’s SRF program.
Improve Transparency: Clear and accessible reporting on PF allocations promotes accountability and enables DACs to plan effectively for available funding and financing opportunities.
2. Limits or “Caps” on the amount of principal forgiveness provided per project or applicant
Unless prohibited by state law, states have the discretion to provide up to 100 percent PF for a project or applicant. However, many states place “limits” or “caps” on the amount of PF that a single project or applicant can receive. These caps typically take one of three forms:
Dollar amount cap (e.g., a maximum of $500,000 in PF).
Percentage cap (e.g., up to 70% of project costs covered by PF).
Hybrid cap (e.g., up to 70% of project costs as PF, with a maximum of $1,000,000). In hybrid models, the limit applied is whichever threshold—dollar amount or percentage—is reached first.
Additionally, caps may be uniform, with all applicants subject to the same limit, or scaled, with PF caps varying based on factors such as applicant size, financial need, or project type. These policy choices significantly impact the attractiveness of SRF funding, particularly for communities where repaying a substantial portion of project costs as loans would impose a severe financial burden.
Policy Considerations
Caps should be designed to balance two key priorities: ensuring that applicants with significant financial constraints receive adequate support, while preventing a disproportionate share of funding from going to just a few applicants or projects.
A uniform cap system may be easier to administer, but it does not always account for the diverse needs of different communities. In contrast, scaled caps—which consider factors such as income levels, population size, or total project costs—can help direct resources more effectively to communities with the highest financial need. Structuring these caps thoughtfully ensures that SRF programs remain both a viable funding source for state-defined DACs and financially sustainable in the long term.
Recommendations
Adopt Scaled Caps: States should tailor PF caps based on community need to ensure fair and effective distribution of limited PF dollars.
Provide Full PF for High-Need Communities: In cases where communities are severely under-resourced, states should allow up to 100% PF for critical projects to prevent under-resourced communities from being left behind when other funding and financing sources are not available or feasible.
3. Project prioritization for DACs
Even if a state effectively implements the first two policies discussed above, ensuring thatDACs are properly ranked remains critical to directing funding and financing to communities most in need. Every state must establish a prioritization framework and rank projects included in the Intended Use Plans (IUPs) on their Project Priority Lists (PPLs). These frameworks can allocate prioritization points to DACs, helping to elevate projects that might otherwise rank lower due to competing priorities. States determine whether to award points to DACs, and if so, whether to provide a uniform number of points to all DACs or scale them based on the level of disadvantage.
Policy Considerations
Prioritization schemes must balance directing funding to DACs with other critical factors such as public health urgency and regulatory compliance. A prioritization system that assigns uniform points to all DACs can improve access to funding but may fail to account for varying levels of need. A sliding scale approach—where prioritization points increase based on the severity of a community’s disadvantage—helps ensure that the most vulnerable communities - defined by state criteria - receive greater consideration.
Recommendations
Give weight to DAC status: Assign prioritization points to DAC projects to improve their ranking in funding decisions.
Use a Sliding Scale: Adjust prioritization points to reflect varying levels of disadvantage, ensuring the most vulnerable communities receive greater support.
State policies on PF play a pivotal role in determining which communities receive the most favorable assistance terms. By maximizing PF allocations, setting appropriate funding caps, and prioritizing projects based on community need, states can strengthen the impact of their SRF programs. These policy choices help ensure SRF dollars are used to expand access to safe, reliable, and affordable water infrastructure.