New Federal Stances on PACE Financing
The debate around Property Assessed Clean Energy (PACE) programs is heating up with the Federal Housing Administration (FHA) announcement permitting FHA-insured mortgages on some PACE-assessed properties.
From 2008 to 2010 PACE was all the rage. Over twenty states adopted enabling legislation for this exciting new way to fund energy efficiency improvements. A local government sells bonds whose proceeds fund green home improvements. The bonds are repaid through supplemental property assessments. For example, a homeowner can fund a $30,000 solar energy system by paying an additional amount on her property tax bill for 20 years. If she sells the house, the new owner takes over the assessment payments. The obligation follows the property – not the borrower.
PACE hit a wall in 2010 in the form of the Government-Sponsored Entities (GSEs), Fannie Mae and Freddie Mac. Most PACE programs provide for super-priority lien status – like property taxes – and ahead of an existing or later first mortgage. Fannie Mae, Freddie Mac and their regulator/conservator, the Federal Housing Finance Agency (FHFA), said no – they would not buy mortgages on homes with outstanding first-priority PACE assessments. They argued that in foreclosure, the PACE lien’s primary position would magnify the mortgage-holder’s losses.
But now, as part of the Obama administration’s “Clean Energy Savings for All” initiative, the FHA will allow mortgages on PACE properties, but only if the specific local PACE program meets a handful of strict criteria, most notably:
- Only the delinquent PACE assessment amounts can take priority over the first mortgage. The non-delinquent PACE balance has to fall behind the first mortgage;
- The PACE obligation can’t be accelerated upon default; and
- In foreclosure, the PACE obligation has to run with the property, passing to the new homeowner.
Lenders may not be quick to embrace this added flexibility. They worry that their obligation to screen each local program creates additional indemnity and risk related to the False Claims Act. Likewise, servicers will bear additional advancing obligations for delinquent PACE payments.
More broadly, will the FHA’s PACE flexibility come at the expense of the Mutual Mortgage Insurance Fund? Servicer reimbursement of delinquent PACE assessments could erode foreclosure recoveries. Moreover, the “go-with-the-property” requirement could reduce the foreclosure sales price since buyers pay less for properties with higher annual assessments, all things being equal.
Apparently, the FHA concluded that all things aren’t equal – that the added value of energy efficiency improvements offsets these loss contributors.
The FHA’s position is now at odds with Fannie Mae and Freddie Mac, who still won’t purchase loans with PACE liens unless they are truly subordinated. And in FHFA’s view, liens that run with properties and aren’t extinguished through foreclosure are not true second liens.
In addition, concerns remain around oversight, disclosures and underwriting for PACE programs. Despite some Energy Department Best Practices and a few state-required underwriting standards, there are still far fewer required disclosures and consumer protections for a $30,000 PACE assessment than for a comparably sized second mortgage.
Where do we go from here? Fundamentally, to bring PACE programs and the secondary mortgage market closer together, more questions need to be answered:
- First, what effect does a PACE lien really have on loss severity in foreclosure? Do the energy improvements create sufficient added value to offset the dampening effect of the continuing lien? Some early research suggests this might be the case.
- Second, are PACE liens really ‘travelling with the property’ as advertised?& Or, are they almost always paid off when a home is sold? If the latter, what does this mean for consumer disclosures? Would some consumers be better off using a traditional home equity line of credit (HELOC) to fund the improvements?
Even if these questions are answered and PACE programs evolve to satisfy the secondary mortgage market’s subordination requirements and incorporate enhanced consumer protections, at the end of the day will the resulting structures still be sufficiently enticing to bond investors?
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