One of the distinctions we often make between energy and energy efficiency is that energy acts more like a cost, and energy efficiency acts more like an investment. Like most investments, energy efficiency works by using an up front expense to generate a stream of economic benefits. Every year, our Energy Efficiency Finance Forum conference looks at ways to manage these up-front costs and how to use that stream of benefits to turn energy efficiency into a viable investment market.
This upfront expense can often act as a significant barrier to energy efficiency. Buying a house used to have the same problem, but a long time ago, some smart people came up with the idea of a mortgage to help work around it.
How to finance energy efficiency improvements
More recently, some other smart people came up with a similar idea for energy efficiency. Property Assessed Clean Energy (PACE) financing is a relatively new strategy for funding efficiency and renewable investments that is really starting to take off. It works like this: let’s say you’ve identified a number of efficiency upgrades for your house, but you don’t have the cash on hand to pay for it. PACE financing will cover those upfront costs, but unlike a mortgage where a bank lends you the money that you use to buy the house and eventually pay back to the bank, a PACE financing company will pay for the upgrades directly and they tack the monthly payment onto your property tax bill by using something called a voluntary assessment.
The difference between PACE and a mortgage loan may not sound like a big deal, but it is. Mortgages work because in exchange for the loan, the bank puts a lien on your house. If you don’t pay, they can foreclose and sell the house to get their money back. Efficiency upgrades would be hard to foreclose on: Banks don’t want to rip out your insulation, and if they did, how much could they sell it for? Instead, PACE companies get their security from the assessment. If a house goes into foreclosure, the assessment stays attached to the house, and whoever buys it picks up payment where the previous owner left off. The same thing happens when you sell the house, which means that you won’t be afraid to undertake larger projects that need longer terms. If you sell the house, the new owner gets the benefits of the efficiency upgrades and pays for them through the assessment. By linking to the property tax, risk to the financer goes down, allowing lower interest rates and sometimes allowing credit to be extended to moderate income homeowners who might not normally qualify for an unsecured loan.
As in past years, PACE was a hot topic of conversation at our Energy Efficiency Finance Forum. Part of the reason is its rapid growth. Even though the concept is relatively new, over $2 billion has been invested in about 97,000 homes through residential PACE financing. PACENation estimates that residential PACE projects have created over 17,000 jobs just in implementing the upgrades. Our research on efficiency projects indicates that the energy savings they generate create as many net new jobs as the implementation does, so the total is really about double the PACENation estimate. PACE is increasingly being used in the commercial sector with about $250 million of loans issued according to PACENation.
Providing clarity for repayment
Anytime people get creative with finance, some questions come up, and PACE is no exception. In its early days, many PACE assessments were what is called first-position, which means that if a home went into foreclosure, any past due PACE payments would get paid before the mortgage did. This is standard for property taxes, but bankers and regulators were concerned that it would increase the risk of mortgages not getting fully paid off. They were also worried that a foreclosure would mean that all of outstanding PACE payments would immediately come due, including future ones that weren’t due yet. Last year, the White House and the Federal Housing Authority announced forthcoming guidance for PACE financiers to follow. Among other things, this guidance will clarify that PACE financing should go in second position—after the mortgage. This is important because it gives PACE financiers clarity on how to structure the assessments to make sure that the homes are still eligible for FHA mortgage insurance, which is critical to many borrowers.
The PACE industry was already moving to make second-position liens the industry standard and to make sure the assessments could stay in place in the event of a foreclosure. They were pleased with the announcement about forthcoming guidelines because they will give them a formal set of rules they could follow and know that they weren’t running afoul of banks and mortgage regulators. With these guidelines, the PACE market appears to be ready for another huge leap forward, particularly if key secondary mortgage players such as Fannie Mae and Freddie Mac decide to adopt these same guidelines. PACE is a powerful tool for communities, helping homeowners save money and reduce energy-related pollution. It’s just one example of what can happen when people think creatively about how to shape the emerging energy landscape, which is the kind of thing that happens regularly at our Finance Forum conference. I hope to see you at next year’s Energy Efficiency Finance Forum in Chicago.
