Why You May Want to Rethink a PACE Loan for Energy-Efficient Home Improvements
Property-assessed clean energy financing offers an affordable way to upgrade your home. But have you read the fine print?
A man puts in an energy efficient window.(Getty Images)
Energy efficiency is important for a lot of homeowners – not just to reduce environmental impact but also to decrease the cost of utilities.
But any major home renovation to achieve greater energy efficiency is going to be expensive. You may not have a lump of cash lying around, and additional financing on top of your current mortgage may seem like a daunting and dangerous burden.
Enter the PACE loan.
Property-assessed clean energy programs, first implemented in the U.S. in California in 2008, are a form of financing that allow property owners to fund energy-efficient retrofit projects at no upfront cost to them. Instead, an assessment is placed on the property and appears as an increase to property taxes until the loan is repaid as many as 30 years down the line.
PACE financing programs, first allowed by state legislatures and then adopted by local municipalities with third-party PACE programs to provide the funding for improvements, have grown nationwide over recent years. As of January 2016, PACE legislation has been authorized in 33 states and the District of Columbia, and 17 of those have active PACE programs, according to the National Conference of State Legislatures. However, most of these programs are specific to commercial real estate, with residential programs rare on a national scale but still fairly common in states like Florida and California.
Homeowners living in jurisdictions with PACE programming are able to fund upgrades like duct replacement, solar panel installation, new insulation and even impact-resistant windows in hurricane-prone areas. In commercial real estate, PACE projects are much larger, with improved air circulation, heating and cooling, and alternative energy sources costing hundreds of thousands of dollars.
Launched in July 2015, the Show Me PACE program in Missouri focuses on PACE financing for commercial, agricultural, industrial, nonprofit and multifamily properties. Just over a year after opening for business, $10 million worth of projects have been completed under the program, says Josh Campbell, executive director of the Missouri Energy Initiative and president of the Show Me PACE board of directors.
“For a commercial property, that money they save as a business, they are much more likely to put that directly back into that business, making them stronger and much more likely to be happy with where they’re at, and more likely to stay at the property longer,” Campbell says.
Missouri requires the financial benefit of improvements made under a PACE project to outweigh the cost of the work itself, and the project must be approved by a third-party lender for an existing loan on the property.
A property assessment automatically becomes the first lien for any property, which means in the case of default or foreclosure, all missed payments on that property assessment must be paid before the mortgage can be paid back. Prior to guidance from the Federal Housing Administration in July, repayment of entire PACE loans took priority over paying back the property’s mortgage.
Therein lies the problem: Mortgage lenders aren’t able to recover as many of their losses in the incidence of foreclosure, all for a loan that didn’t require underwriting or credit approval. Fannie Mae and Freddie Mac won’t back mortgages with existing PACE assessments unless first-lien status is given to the FHA loan. Campbell notes Missouri clarified PACE programs' first-lien status to only account for that year's assessment status if a property goes into default. But not all states have defined the lien in the same way, leaving lenders at risk.
In June, the Federal Housing Financial Agency testified to the California legislature regarding PACE financing.
“The financing concept is simple – if a residential property has to lose 90 percent of its value before a PACE lender incurs a loss, the investor has a very attractive investment opportunity,” Alfred M. Pollard, general counsel to FHFA, said in his statement to the California legislature. “However, that opportunity comes at the expense of existing lien holders, who unexpectedly bear a new risk of loss, and, in some instances, to the disadvantage of consumers.”
California’s acceptance of PACE programs in many municipalities throughout the state was initially met with excitement from real estate professionals, explains Alex Creel, vice president of governmental affairs for the California Association of Realtors. But concern quickly took over when programs implemented didn't appear to clearly explain the potential for difficulty in future sale of the property, refinancing and mortgage lending deals, Creel says.
When selling a home just a few years after completing a PACE project on the house, you could find yourself having to pay off the entire assessment before you can close a deal, Creel says.
In his testimony to California legislators, Pollard echoed the concern about homeowners understanding the costs: “PACE programs in many, but not all, instances are administered by third parties that do not follow the same consumer protection requirements applicable to residential mortgage lenders.”
Both the FHFA and CAR stress that affordable solutions to energy-efficient renovations in homes as well as commercial real estate are important – and necessary – to reduce negative human impact on the environment. But the current PACE system creates more short-term problems for homeowners and mortgage lenders that wouldn’t exist otherwise.
For energy-efficient retrofitting, the FHFA recommends more traditional lending options, some even designed to finance energy efficiency, that operate similar to a second mortgage.
A home equity line of credit is one recommended alternative to PACE financing. This option is well-suited for home improvements that save money through reduced utility costs and add value to the property in the long run. As with any form of borrowing, homeowners should approach the process cautiously and carefully weigh the loan amount with a solid plan to repay it.
And while residential PACE programs may not be as informative as they could be, that doesn’t mean all PACE financing opportunities aren't worthwhile. As Campbell notes, Missouri requirements for PACE financing have helped foster positive outcomes for not just the property owners receiving funding but also for the lenders already involved in the property, as those requirements encourage conversation and negotiation so both sides feel confident about a project.
A California state law that goes into effect in January 2017 requires PACE lenders to provide borrowers with disclosure information about the loan they’re taking on – similar to the TILA-RESPA Integrated Disclosure forms now required for all mortgages issued nationwide.
Creel says this law, which as a bill was sponsored by CAR, will help homeowners understand what they’re getting into when they sign on for PACE financing and be prepared for obstacles in the event they want to refinance or sell their home.
But even then, Creel says it won’t completely solve future problems: “A lot of times people don’t read what they sign, unfortunately.”