By JACOB CORVIDAE and MARTHA CAMPBELL
Last month, the Federal Housing Administration (FHA) announced it will stop insuring new mortgages on homes with property assessed clean energy (PACE) loans. As to what motivated its decision —
according to its letter to the U.S. Department of Housing and Urban Development — the FHA is “concerned with the lack of consumer protections associated with the origination of the PACE assessment, which are far less comprehensive than that of traditional mortgage financing products.” This announcement directly contradicts guidance issued by the FHA in 2016.
Rocky Mountain Institute feels this decision is misguided for three key reasons:
- The FHA overstates the risk of PACE to taxpayers while failing to acknowledge or account for the significant default risk that the excessive energy expenditures of inefficient homes can create for a homeowner.
- This will inhibit homeowners from making valuable home improvements, while curbing PACE’s job-creation potential in the construction and renovation industry.
- It undermines existing state-level consumer-protection standards that are in place and federal standards that are in development, and may in fact guide homeowners toward more risky financing solutions, such as high-interest rate credit cards, that lack such standards.
PACE, founded in the early 2000s as an innovative way to finance home energy upgrades, tackles a significant market failure. It does so by increasing American households’ access to financial resources so they can afford cost-saving energy performance retrofits — a need which has largely been unfulfilled by any other financing instrument.
PACE not only removes the upfront cost of energy-efficiency, renewable-energy, and water-efficiency investments for homeowners, but also provides them with a more affordable financing alternative by offering longer payback terms and low repayment costs that are transferable upon a home’s sale (along with the benefits of the home improvements). PACE, like any other assessment, is attached to the property — not the individual — which makes it an innovative and unique green financing instrument. It also serves the community-wide interest in improving the housing stock while correcting for the failure of the market to fully recognize the impact of energy profiles on housing valuations.
To date, residential PACE (or R-PACE) has been used to finance $4.2 billion in home energy improvements, creating over 36,000 jobs in the states in which R-PACE is enabled, according to PACENation. R-PACE has been used successfully to finance over 158,000 retrofits in three states since 2008, which demonstrates its market acceptability, scalability, and potential as a transformational market-financing tool. It is worth noting that R-PACE has seen unprecedented growth in California that has largely been driven by enabling state legislation. This growth has now started to spread across other states like Florida and Missouri.
The real risk of high energy bills
This new guidance from FHA is like telling someone to tie their shoes before running away from an attacker; it’s distracting from the real threat. Home energy costs present a material threat to the mortgage industry and to the financial health of homeowners, and yet FHA has not taken any steps to address this threat. Worse, by attacking PACE, it is removing an important tool for homeowners to improve their energy bills, making that threat worse.
A study by the University of North Carolina’s Center for Community Capital analyzed actual loan-performance data obtained from CoreLogic, the lending industry’s leading source of such data. The study found that default risks are, on average, 32% lower in energy-efficient homes, controlling for other loan determinants. In other words, if we were to consider efficient homes the norm, then non-efficient homes have a 47% greater default risk, on average.
Meanwhile, the Energy Programs Consortium reports that default rates for PACE customers are far lower than for typical customers. The burden of utilities is quite high for most American households. A 2017 study by ATTOM Data Solutions and UtilityScore found that the average U.S. household’s energy and water bills add 25% to the monthly cost of homeownership.
Homes with poor energy performance are a much more significant threat to consumers than homes with good energy performance. Despite the fact that homeowners say that energy efficiency is the top unmet need for their homes (greater than safety concerns, school access, or kitchen upgrades), the real estate and mortgage industries have failed to provide information for consumers to make informed decisions. Worse yet, homes with poor energy performance often have a greater potential for moisture problems, pest infestations, drafts, and other problems that can contribute to asthma and other health concerns.
By ignoring these consumer protections, the FHA is steering consumers who want to upgrade their homes toward far more risky options. A 2015 report published by BMO Harris Bank found that 58% of Americans pay for home improvements with savings, 18% pay with credit cards, and 17% use home equity lines of credit. With 76% of Americans financing their home improvements through savings or credit cards, it appears that the market for home improvement financing models that could simultaneously benefit consumers’ financial health is large.
Especially important to note is that 37% of PACE financing is used to respond to emergency repair or replacement needs, while an additional 23% is used to repair something that “was likely to fail in the near future” according to a 2017 study by Research Into Action. These are situations where homeowners may not have been planning to make an upgrade, but in the face of a broken furnace, air conditioner, or roof had to protect their health, safety, and home investment. Therefore, relying on savings or credit cards may often be their only option in the face of an emergency, since traditional financing often takes too much time or may not be available to as many homeowners.
The same BMO Harris report found that 45% of Americans undertaking improvements also intended to make their homes more energy-efficient, demonstrating the importance of lending models that enable homeowners to meet multiple home improvement goals.
With the historical momentum and expansion of PACE, parties at the state and national levels have set and implemented robust consumer-protection guidelines. The Department of Energy’s “Guidelines for Pilot PACE Financing Programs” served as the basis for early best practices established in 2014 by PACENation, an organization focused on promoting PACE by providing leadership and support to a growing member base (then operating as PACENow).
PACENation — in collaboration with industry leaders — developed and released Consumer Protection Policies Version 2.0 earlier this year. The policies were adopted by the California Statewide Communities Development Authority and the Western Riverside Council of Governments — both of which heavily informed California’s PACE policies — and now serve as an industry standard.
Today, more consistent consumer protection standards upheld across local communities and states will help ensure the successful growth and scaling of residential PACE programs, while protecting the integrity of PACE as a public–private partnership. Standardization of operations across jurisdictional boundaries will reduce the need for customization and enable consistency, which will allow PACE programs to continue to streamline their operations, and thus provide lower costs to participating homeowners.
FHA: Get out in front of the market
Secretary of Housing and Urban Development Ben Carson stated, “Assessments such as these are potentially dangerous for our Mutual Mortgage Insurance Fund and may have serious consequences on a consumer’s ability to repay, or when they attempt to refinance their mortgage or sell their home.” But this statement doesn’t match the data available about where true default risk lies. So far, customers with PACE financing have a lower mortgage default rate, while non-energy-efficient homes have a 47% higher default risk than efficient homes.
We laud Carson’s concern about default rates, and agree that the industry should act fast to protect against defaults — but if that’s really the concern, then the industry needs to move to integrate energy use into the appraisal process so that homeowners understand the real cost of homeownership and can get better mortgages to support more efficient homes. In fact, much of the industry is moving toward improved models to address this, which FHA could support, rather than simply sitting back and being reactive.
If FHA is serious about its concern with default risk, it should respond to the default risk posed by energy costs and join the conversation on further enhancing consumer protections for PACE, ones that are appropriate to its use and size in relation to home valuations. Let us work toward expanding safe options for consumers to upgrade their homes and decrease their monthly costs. Imagine a more energy-efficient housing stock that reduces default risk by 30%. RMI has worked to find nonpartisan, economically viable market solutions to better energy use for 35 years. If HUD and the FHA are interested in a solution, we are prepared to help.
Jacob Corvidae works as a manger in the Rocky Mountain Institute’s Building Practice. Martha Campbell is manager of the Residential Energy+ team in RMI’s Buildings Practice. © 2017 Rocky Mountain Institute. Published with permission. Originally posted on RMI Outlet.