Will PACE Financing Damage the Mortgage Market?

The Federal Housing Finance Agency (FHFA), which oversees the government agencies Fannie Mae and Freddie Mac, is now joining them in saying that Property Assessed Clean Energy (PACE) financing “could damage the mortgage market.”

PACE financing is an important program that addresses multiple barriers to energy efficiency. First, it addresses upfront cost: although energy efficiency measures usually pay for themselves, most require an up-front investment which many people have trouble making. PACE financing also helps address split incentives. Because efficiency improvements can take several years to pay back, and most Americans move every few years, the benefits of efficiency don’t always accrue to the people who invest in them. With PACE, the loan used to make the improvement is assessed on the property, so the person who is saving money in energy costs is always the same person who is paying for the energy improvements.

Jonathan Hiskes at Grist makes the counter-argument that PACE financing is not really something new, as the FHFA and the mortgage giants claim, and I agree with him, but there are several stronger arguments against the mortgage regulator’s position that I have not yet seen made.

The FHFA is worried that the “lending is not based on the homeowner’s ability to pay, it bypasses consumer protections such as the Truth-in-Lending Act, and it may not lead to meaningful reductions in energy consumption.” I’ll address each of these points in turn:

Ability to pay. The lending does not need to be based on the borrower’s ability to pay, because the energy improvements improve that ability to pay. For example, Boulder Colorado’s now canceled PACE program required that the homeowner first get an energy audit, which is then used to estimate the cost savings of possible energy improvements. If the homeowner is able to pay for his or her current mortgage (which, supposedly, is based on his ability to pay), then after the energy improvements and the PACE loan, he or she should have better cash flow, and be better able to pay. In other words, PACE should improve the owner’s ability to pay, and actually strengthen the mortgage market.

Consumer protections Unlike complex mortgages, the most important thing about a PACE loan is that the monthly payment be less than the monthly savings, so they are inherently easier for consumers to understand. But if consumer protections are necessary, there’s no reason they could not be added to PACE lending programs without canceling the whole program, as the FHFA seems to want.

May not lead to meaningful reductions in energy consumption. Quite simply put, this is an attempt to throw the baby out with the bathwater. A good PACE program requires an energy audit and professional installation in order to ensure energy savings. It’s important to design PACE programs carefully, but that’s true for any lending program, or any program whatsoever.

Rather than putting a stop to all PACE lending, as has happened, good programs (such as Boulder’s) that do provide some assurance that energy savings will be achieved should continue, since they strengthen borrower’s ability to pay rather than weakening it.

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7 Comments

  1. [...] Konrad examines the question, “Will PACE financing damage the mortgage market? PACE is “Property Assessed Clean Energy” financing, a financing mechanism through which [...]

  2. [...] Assessed Clean Energy Micheal Giberson over at Knowledge Problem bounced off my article on why PACE financing would be unlikely to damage the mortgage market to mention several of his own worries about how such programs are [...]

  3. I dont understand how something that saves so much in electrical bills and usually increases a home value by almost 4 or 5 times what it would have is deemed damageable to the mortgage.

  4. Jay B. said

    It is certainly the way how to strengthen borrower´s ability to pay rather than weakening it. On the other side it is true that unemployed people wouldn´t put them into risky mortgage business. But if the mortgage already exists (based on the ability to pay the mortgage) there is very likely to see the energy improvement together with rising homeowner living standard. On the end this is a part of green healthy living we want to have…

  5. David Levy said

    Financing for efficiency upgrades would not be such a problem if the returns on the investment were clearer. I’ve been thinking of upgrading from oil to a new high efficiency gas furnace and (a) who knows what gas prices will be and (b) the subsidy on the furnace (which I’ve already paid for out of our utility bill surcharge) is far more than offset by the hugely inflated plumber’s estimate – the plumber is chosen by the utility (Nat. Grid), so is in a quasi-monopoly position. There’s a critical need for more competitive pricing in the fragmented residential market. See my recent post on this:
    http://climateinc.org/2010/06/energy-efficiency-adventures/

    • Tom said

      Excellent point, David. Your experience shows the importance of good energy efficiency program design. When your utility forces you to use one particular plumber to install your furnace, they are creating an artificial monopoly, which the plumber then exploits, allowing him to capture nearly the entire rebate.

      PACE programs hold the same risks as you saw with your DSM program. But not all DSM programs have those flaws, and neither will all PACE programs. The right goal is to have guidelines for PACE (and DSM) programs so that they really do bring benefits to consumers, not just contractors.

      We need good PACE programs, not no PACE programs.

  6. Gentlemen …

    You both make great points … one additional comment that has been missed in many discussions about PACE financing, is the fact that PACE loans are funded by bonds which are securitized and sold into the secondary market, and just like all Fannie/Freddie and FHA 1st mortgage loans, to be sold into the secondary market, the loans need to be in 1st position … so today, the decision is “which is more important?”, the actual mortgage loan, or the PACE financing.

    The good news, there are attractive alternatives in the market which can fund the energy related improvements … check out my blog for additional details … http://www.americansforenergyindependence.org

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