Nationwide, PACE Financing in Jeopardy
In a move that will disrupt the operation of property assessed clean energy (PACE) financing programs for the foreseeable future, the Federal Housing Finance Agency directed Fannie Mae and Freddie Mac to reject future PACE loan requests made by homeowners. Fannie and Freddie dominate the national mortgage market, and their refusal to participate threatens the current and future viability of PACE financing.
For over a decade consumers have been searching for an innovative financial tool to help them overcome the up-front capital cost hurdles of investing in deep energy efficiency improvements or installing small renewable energy systems on their property – especially in instances where property owners do not intend to own the property long enough to realize the full payback on the investment, but want to do the right thing.
PACE programs allow local governments to lend money to homeowners for energy efficiency and renewable energy improvements. The loan is repaid through a special assessment on the property, theoretically allowing the loan to continue to be paid off even if the property is sold to a new owner. Sweeping the nation, in just under three years, twenty-one states and the District of Columbia have passed laws authorizing PACE, and cities and counties in California, Colorado, and other states have successfully created and operated programs.
How does PACE work? This loan is typically secured through a senior lien on the property, ensuring that the lending government is paid off first in the event of foreclosure ahead of other creditors, including mortgage lenders. The lien’s senior status increases the likelihood that the loan will be repaid and makes the local government’s financing bonds more attractive to investors, resulting in lower interest rates and costs for the government and homeowner alike. However, mortgage lenders could bear a larger risk in the event of a default, as the lien must be paid off before the mortgage lender can begin to recover.
Does NC offer PACE? In 2009, the North Carolina General Assembly took a very deliberate approach to offering cities and consumers innovative financing options, passing two bills (HB 1389 and SB 97) that taken in combination authorize cities and counties to establish their own PACE programs. Due to lack of clarity in the original legislation no local government programs have been fully implemented to date. These ambiguities are largely corrected in NC House Bill 1829, which passed into law on July 10.
Innovation is rarely easy or perfect on the first try - on May 5, the federal debate over the form and function of PACE financing reached a fever pitch when Freddie Mac and Fannie Mae entered the debate with a letter asserting that PACE loans violate the lenders’ charters. FHFA's statement affirms this position and pushes lenders to take action to secure their mortgages against the possibility of PACE loans. In addition to directing lenders to build a veto into their mortgage covenants, the Federal Housing Finance Agency instructs lenders to alter their underwriting criteria to include the risk of a future PACE loan, which could result in higher interest rates for consumers.
While homeowners with existing PACE loans will still be able to continue their participation, and those few programs that do not impose a senior lien will be unaffected, for most states it is back to the drawing board to find an approach that works for the major mortgage lenders.
Without the support of the mortgage industry, PACE becomes a riskier proposition for homeowners. Even if a homeowner obtains a PACE loan, upon resale the next owner’s mortgage lender would almost certainly refuse to accept the lien. The initial owner would be forced to pay off the lien before selling the house, suffering an unrecoverable financial loss. The incentives for PACE participation disappear. In this scenario, the future of PACE financing is on hold.
Solving this problem will likely take either significant structural change to remove primary lien status in existing PACE legislation (thereby decreasing attractiveness to bond markets) or congressional action to alter Freddie and Fannie’s charter to allow the lenders to take a subordinate lien position. The Department of Energy has informed local governments that an immediate fix is unlikely.
The directive directly impacts one of the two methods that North Carolina authorizes cities and counties to use. While using special assessments to finance improvements is effectively prohibited, revolving loan funds may still be established. Under a revolving loan fund program, the local government could make loans to residents without imposing a senior lien on the property. State law, however, forbids such programs from borrowing money to fund the initial loans. This significantly limits the impact of revolving loan funds
