How PACE Loans Work
The Pros and Cons of PACE Funding
Saving water and energy is beneficial for the environment and can result in lower utility costs for you. But major upgrades like drought-resistant landscaping and solar panels can be costly. So, how can you make sustainable upgrades without breaking the budget?
A PACE loan might be a viable option for funding. PACE financing makes it easy to qualify for relatively affordable long-term loans, but there are pros and cons of going this route.
Details of PACE Programs
Property Assessed Clean Energy (PACE) is a way to borrow money for clean energy projects. Property owners repay the borrowed funds along with their property taxes, and the assessment remains with the property—not with the original borrower—if it hasn't been paid off by the time a property is sold. Approval for PACE financing is primarily based on the equity in the property being upgraded, which serves as collateral to secure the loan. The homeowner’s credit score is less of a factor.
The PACE funding may not exceed 15% of the property's value. And the total loan-to-value ratio of the PACE assessment and any outstanding balances on loans related to the property must not exceed 97%.
As of September 2020, PACE funding was available for residential properties only in California, Florida, and Missouri; PACE-enabling legislation is active in 37 states plus D.C., and PACE programs are operating in 24 states plus D.C..
PACE financing programs go by several different names. In California, for example, they include CaliforniaFIRST, FortiFi, HERO, and Ygrene. In all three states, in addition to energy-conservation-related projects, PACE funding can be used to replace a roof. In Florida, it can be used to help protect your home against hurricanes. In California, it can be used to improve water efficiency, including the installation of low-flow plumbing and drip irrigation.
Because PACE money is paid back as an assessment through your property taxes, it's not technically a loan. The borrowing is set up as a lien against the property, one that typically takes precedence over the mortgage lender's.
Evaluating PACE Financing
While there are several advantages to PACE financing, it is not the best option for everyone. That's why it's also important to be aware of the disadvantages of receiving PACE funding.
Approval is often easier.
No down payment is necessary.
The assessment stays with the property.
Terms are flexible.
Interest payments may be tax-deductible.
Some contractors push PACE borrowing to serve their own interests.
Payments might be due in large chunks once or twice per year.
Interest rates are higher than traditional loans.
Selling the property might be more challenging because of the assessment.
The assessment is secured to the home, increasing the risk of foreclosure.
Advantages of PACE Funding
These programs have several features that make them appealing to borrowers.
- Easy to qualify: PACE eligibility is relatively easy. Compared to home equity loans, which are popular alternatives for expensive home improvements, the approval criteria seem relaxed. Your FICO credit score is less important with PACE, but current or recent issues in your credit reports can cause problems. You also must be current on all property taxes.
- 100% financing: PACE allows you to fund the entire cost of a project with no need for a down payment. As a result, you can get started quickly without having to save up for projects or move money around. Of course, larger loans translate into higher interest costs and sizeable payments.
- Can be transferred to the next owner: If you sell a property after making improvements, you don’t necessarily have to pay off the loan. The loan is attached to the property, so it can be transferred and paid off by the next owner. This can be a good thing, depending on whether or not you’re the buyer. Not all buyers are interested in the added expense for these improvements.
- Time to repay: Significant improvements can be expensive. PACE loans can be paid off over extended periods of time (10-20 years, for example). As a result, payments can be kept relatively small. However, as with any loan, the longer you take to repay, the more interest you’ll pay over the life of that loan.
- Potential tax credits: PACE funding might make it easier to qualify for environmental tax credits. Check with your tax advisor before making any decisions. When timing is a concern, PACE makes it possible to complete a project before tax credits expire, and getting a large loan allows you to install everything in one year (as opposed to stringing things out over several years to spread out the cash flows).
- Tax deduction for interest payments: The interest you pay on PACE assessments should be tax-deductible. However, the larger standard deduction implemented by the 2017 Tax Cuts and Jobs Act makes it less likely a homeowner with a PACE assessment would itemize that deduction.
Disadvantages of PACE Financing
Before using PACE funding for your project, get familiar with some of the pitfalls.
Conflicts of Interest
PACE programs often rely on construction contractors to promote them. Most service providers are honest, and it’s ultimately up to buyers to make smart decisions, but a small percentage of contractors may make misleading statements just to score high-paying jobs. In addition to getting paid for the work they’ll perform, contractors might receive additional referral fees from a lender if they arrange the project's funding, so the potential for conflicts of interest is real.
Even if you choose an extended repayment period, making payments can be a burden. Most people think in terms of monthly payments, but property assessments often are paid only once or twice per year. You may be faced with a surprise expense when it’s time to make those inflated payments.
If your mortgage loan servicer pays your property taxes through an escrow or impound account, you should be able to make your PACE payments in monthly installments as well.
Qualifying for PACE funding is relatively easy. However, interest rates are sometimes higher than a home equity loan or line of credit—especially if you have good credit. Whether or not you can get a better deal depends on numerous factors, but PACE financing is not necessarily cheap.
Costs and Benefits
Not all improvements made using PACE funding will result in energy or water cost savings that exceed the borrowed amount, and some may not produce much in the way of savings at all. You should thoroughly research the proposed improvements and determine whether making them will ultimately pay off for you.
Risk of Foreclosure and First-Lien Status
PACE borrowing is secured by your home, so it’s possible to lose your home in foreclosure if you don’t make the payments. And because the PACE lien is generally in first position—meaning, in front of your mortgage lender—you risk foreclosure even if you make your regular mortgage payments as agreed. Additionally, homes with a PACE lien are not eligible for a mortgage financed by Fannie Mae, Freddie Mac, or the Federal Home Loan Banks. That could make it impossible to sell the property to someone whose mortgage was obtained through a federal lending program.
Looks can be deceiving
The risks above do not mean that PACE programs are bad. However, it’s worth knowing the pros and cons of these arrangements before signing up. Unfortunately, the risks often are overlooked because PACE programs are perceived to be “safe.”
- Government-related? Local governments make PACE funding available, and PACE programs are sometimes confused with government-offered programs. Ultimately, they’re just loans like any other loan—they are an obligation that must be repaid, and there are consequences for failing to repay.
- For a good cause? It feels good to help the environment, and PACE financing helps you pay for green projects. However, there also are several entities involved who could be more interested in making a profit than making a difference. Critics argue that these loans have similarities to subprime loans.
- Tax-deductible? It may be possible to deduct interest costs related to your project. However, tax laws are complex—you need to speak with a local tax preparer to verify your ability to take deductions.
Property owners sometimes believe that the entire cost of a project is deductible because the payment is part of a property tax bill, and that may not be accurate.
How to Use a PACE Loan
In some cases, it makes perfect sense to use PACE funding for a project. Here are some tips to help you get your money’s worth.
Talk With the Lender Directly
After you learn about PACE from a contractor, have another discussion with the actual lender or PACE financing organization. It’s essential to understand exactly what you’re getting into. Learn the pros and cons of different options, and see how much you’ll pay. Even ethical contractors can forget to include important details, and they don’t know your complete financial situation. Go directly to the source for details, and have that discussion when your contractor is not present. That way, you can speak freely without worrying about hurting anybody’s feelings.
Compare Other Types of Loans
Shop among online lenders, local banks, and credit unions in your area. FHA 203K loans can also fund home improvements and require a relatively small down payment. You might even be able to fund your project with a personal loan and avoid pledging collateral.
Know the Terms
Find out what rate you realistically can expect, and find out what closing costs you’ll be required to pay. Also, find out if you’ll end up with a lien on your home (which will happen if you use PACE financing or a traditional second mortgage). You might still qualify for tax credits—and possibly even an interest cost deduction—if you use other loans.
Get Quotes From Multiple Contractors
When you’re not paying cash up-front, anything seems affordable. But there’s still an opportunity to save money (and lower your payments) by going with the most competitive contractor. Just remember that sometimes you get what you pay for, so choosing the lowest price may come back to haunt you.
Budget and Pay Cash
It’s not the easiest way to do things, but you always have the option of delaying your project, saving money, and paying in cash to get it done at some point in the future. This more patient route will save you money on interest costs, and you’ll have additional options when it comes to choosing contractors and the exact work they perform.
Selling (or Buying) a Property With PACE
PACE loans are unique because they stay with the property—not the original borrower.
If you’ve used PACE to fund improvements, you may still owe money when you decide to sell. In that case, you can sell the improved property, and the buyer can take responsibility for repaying. In other words, the new property owner will get the assessments going forward. In some ways, that makes sense because the property is actually worth more. However, some buyers may be reluctant to take on those payments, and they may even have a hard time getting financing if a property has additional assessments.
If you prefer, you always can pay off the PACE debt yourself, which makes your property more appealing to potential buyers. Everything is negotiable in real estate: You can charge a higher price for the paid-off improvements, or you can accept a lower price for a property that comes with higher expenses (at least temporarily).
If you’re considering buying a property with existing PACE debt, take some time to find out how that debt will affect your transaction. Presumably, you’ll benefit from the improvements, so it may be worth taking over the payments. For example, you’ll have lower electric bills if the house has a robust photovoltaic system, and you’ll enjoy those lower bills long after the PACE assessments end.
Before you go too far, speak with your lender to find out how they handle PACE issues. In some cases, a PACE lien needs to be in the first position, but some PACE programs are willing to take the second position behind your home purchase loan.