Under newly issued guidance, the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) will begin insuring mortgages on qualifying properties with PACE assessments.
Unlike the active commercial Property Assessed Clean Energy (PACE) market, the residential PACE market has largely been shut down until this guidance. Homes with a PACE assessment have been ineligible for FHA- or VA-insured mortgages, which drastically restricted the refinancing and resale market for homeowners that take advantage of PACE financing.
The ineligibility came from a prohibition of any other liens on the subject property at the time of insurance. According to the new guidance, a PACE assessment will no longer prevent a mortgage from being insured by the FHA or VA, provided that the following requirements have been met under the state laws where the property is located:
- The annual PACE obligation must be escrowed by the lender (like typical property tax escrows).
- The property may become subject to a lien senior to the insured mortgage for only the delinquent portion of a PACE obligation, and the PACE obligation may not accelerate in the event of delinquency.
- The PACE obligation may not restrict transfer of the property to a new property owner, and conveyances related to the PACE obligation that require a third party's consent before transfer of the property are prohibited, unless the provisions may be terminated at the option of, and at no cost to, the property owner.
- The existence of a PACE obligation on a property is readily apparent to mortgagees, appraisers, borrowers and other parties to an insured mortgage transaction, and information on PACE obligations must be readily available for review in the public records where the property is located.
- In the event of the sale (including foreclosure) of the property, any outstanding PACE obligation remains with the property. Unless a payoff is negotiated, the buyer will assume the obligation and will be responsible for the outstanding payments.
According to the Department of Housing and Urban Development's announcement, the changes are part of the Obama administration's Clean Energy Savings for All Initiative, which aims to "expand access to clean energy technologies to every American family with the option to transition to solar energy and make improvements to their homes to cut their energy bills."
This is a great step forward. Yet, there are still several things that will need to be cleared up before the market will really open up.
First, FHA and VA insurance are only part of the story. FHA- and VA-insured loans represent more than 25 percent of the residential housing loans originated in the United States. Most conventional mortgages, however, must satisfy underwriting criteria of the Federal Housing Finance Authority, as conservator for Fannie Mae and Freddie Mac, which has yet to provide any real guidance on the matter.
Second, conventional project financiers could find the acceleration restriction problematic. One of the primary rights in a typical security package is the right to accelerate the loan (that is, call the entire loan upon default, rather than one or more missed payments). This could force project owners to look to nonconventional lending sources, which could push up the financing cost and limit one of the potential benefits of a PACE-backed loan. By comparison, commercial PACE lenders negotiate acceleration and lien priority with other secured parties, and more limited structures have resulted in higher borrowing costs.
Third, transfer restrictions could have significant implications on power purchase agreements (PPAs) or solar leases. Allowing PACE obligations to travel with the property upon sale is a significant improvement, but it could be tempered by the requirement that third-party consents to transfer must be at the option of the homeowner and without penalty. It is unclear whether these provisions would affect requirements that, upon transfer of the associated property, a solar system must be purchased (unwinding the PACE financing) or transferred to a new, qualified, long-term PPA or solar lease. Clarification will be required to determine whether such a condition could be considered a penalty in violation of the policy.
Backing Up, What Is PACE?
PACE programs allow property owners to leverage private sector financing to make energy efficiency and renewable energy upgrades to their properties. The improvements are repaid by the property owners through a special assessment on their property tax bill, often providing a longer repayment period than conventional financing and creating a reliable repayment mechanism that can make improvements more affordable.
PACE financing is a bipartisan initiative that has active programs in 19 states (and Washington, D.C.) and enabling legislation in 32 states (and D.C.). PACE has been used by more than 100,000 households to make properties more valuable, healthy and comfortable. PACE has been used to finance energy efficiency, renewable energy, water conservation and other resilience upgrades to homes, including new heating and cooling systems, lighting improvements, solar panels, water pumps and insulation.
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