What Mortgage Underwriters are Missing about PACE

By: Adam Feldman

Property Assessed Clean Energy (PACE) bonds are a powerful tool for promoting energy retrofits. Local governments issue PACE bonds to fund individual property owners’ upfront costs in installing clean energy improvements–insulation, new water heaters, and solar panels, etc. The property owners pay the funding back through property tax assessments over time, just like they pay for other public benefit improvements such as streetlights and road repair. The idea is that property owners can pay this funding back because their energy bills are lower.

Unfortunately, the push to develop PACE programs has reached an avoidable stalemate. Federal Housing Finance Agency (FHFA), the regulator for the nation’s largest mortgage lenders Fannie Mae and Freddie Mac, has brought many of these programs to a halt by adopting lending policies that handicap the real estate markets in municipalities that issue PACE bonds. FHFA seems to be concerned that PACE bonds, as tax assessments, sit in senior lien position to mortgages, depressing the value of the mortgages FHFA holds.

While FHFA have raised legitimate concerns about underwriting standards in opposition to PACE, these concerns can be quickly and easily addressed by reasoned and honest consideration of existing underwriting methodology. Quite a bit more is understood about PACE program requirements than the FHFA acknowledges. In fact, FHFA’s overprotective zeal is depriving the nation of a truly beneficial, game-changing public policy.

FHFA’s main concern is that, by inserting PACE liens in front of the first mortgage, participating property owners are weakening the financial position of the mortgage holder and reducing the borrower’s ability to meet their mortgage payment obligation. Looking at this solely from a financial perspective, the FHFA has something of a case because the “size and duration” of these liens can be larger and longer than other assessments. However, the other assessments to which the FHFA refers–and which have been the domain of local governments for decades–do not typically add value to the property in the way that a PACE lien does. Calculating this added value remains difficult for lenders, because of a missing puzzle piece in mortgage underwriting methodology.

Currently, when someone applies for a home loan, (note that FHFA’s authority is only over housing, not commercial projects) the underwriter looks at two main numbers: (1) loan-to-value and (2) debt-to-income or ability to pay. Let’s address these separately and then look at how they can and should work together.

1. Loan to Value: Since the credit crises, lenders are no longer offering no-money-down loans. This is just one of the ways lenders are reducing risk as the pendulum swings away from previous excesses. However, the impacts of a PACE lien to the loan-to-value are minimal since the improvements are likely to add approximately as much value as they cost. An example:

Assume the owner of a $500,000 property participates in a PACE program and completes $50,000 worth of efficiency improvements on the property. (Programs limit improvements to 10% of assessed value.) While some zealous proponents of PACE would claim that this home should now be worth $550,000, it is only fair to note that now additional obligations exist on the property in the form of the PACE lien. If the bank were to take possession, any prudent buyer would discount their offer by the present value of these future obligations, bringing the value back down. However, a buyer should also see the ongoing value of a more efficient home (reduced future energy expenses), and add the present value of the net savings back into their offer price. Depending on a variety of factors, the savings and costs should come close to offsetting each other, leaving the lender in approximately the same position as before the PACE lien. The dilution is thus limited to any delinquencies, an outcome that could be easily avoided via an escrow mechanism with which lenders are already very familiar. (Lenders often provide a preferential interest rate because of the risk reduction such escrows provide). This leads us to the next category in the underwriting process.

2. Debt to Income: Mortgage underwriters look at a variety of things when determining the ability of a borrower to make good on their mortgage obligation. First, they look at income. Luckily we are past the days of ‘stated income’ loans, so that side of the equation has been cleaned up. On the expense side, lenders look at principal and interest, property taxes, insurance, auto debt, credit card debt, student loans, alimony and child support, among other expenses. One thing they do NOT look at is utility expense. Ignoring utility bills, which can often be a significant portion of total monthly obligations, is not in line with conscientious underwriting standards.

Simple methods exist, from historical utility expenses to more in-depth home energy audits, that can provide a reasonable estimate of utility expenses. If lenders took these into account, it would be quite simple to analyze the impact of a PACE lien. Lenders would actually have ready access to the tools to look at both sides of the equation.

While personal habits make utility usage difficult to estimate, we do know that a more efficient home uses less energy than a less efficient home. As energy prices continue to rise, it will only become increasingly important for lenders to be aware of the implications of energy costs. The more thorough underwriting standards become, the more risk will be reduced and the more easily we can embrace innovative solutions to some of today’s most pressing challenges. PACE is one of those solutions.


Adam Feldman is the founder and president of Amada Group, LLC, an investment fund manager providing investors with profitable investments that make a positive impact.

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4 responses

  1. Wonderful work writing this article. Thank you.

    Also, from a human point of view, it seems like we could at least TRY this program. We’ve got to start taking some bigger steps toward energy independence as a nation.

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