How PACE Loans Work
The Pros and Cons of PACE Funding
Saving water and energy is good for the environment and can result in lower utility costs. But big upgrades like drought-resistant landscaping solar panels can be costly. If you’re looking to make green improvements, a PACE loan might be an option for funding. PACE financing makes it easy to qualify for relatively affordable long-term loans, but there are pros and cons to using these programs.
What Is PACE?
Property Assessed Clean Energy (PACE) is a way to borrow money for clean energy projects. Property owners, including homeowners and businesses, get financing for upgrades and repay through property taxes. Approval for PACE financing is mainly based on the equity in the property being upgraded, which will be used as collateral to secure the loan, and you can typically borrow up to 15% of a property’s value.
Common uses of PACE include solar installations, energy-efficient heating and cooling, water-saving landscaping, and numerous other projects for residential and commercial properties.
PACE is only available in locations where state and local laws allow this type of financing, and where local programs have been developed. These programs go by several different names, including the popular Home Energy Renovation Opportunity (HERO) program and Ygrene.
While there are several advantages to PACE financing, it is not the best option for everyone. It's also important to be aware of the disadvantages so you can choose the best loan program for your needs.
Loan approval is often easier.
No down payment necessary.
Loan can be sold along with the property.
Loan terms are flexible.
Tax credits may be available.
Some contractors push PACE loans to serve their own interests.
Payments might be due in large chunks once or twice per year.
Interest rates are higher than many other loan types.
Selling the property might be challenging if buyers don't want the loan.
Loan is secured to the home, increasing the risk of foreclosure.
Advantages of PACE Loans
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 mean higher interest costs and higher 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. Whether or not that’s a good thing probably depends on whether or not you’re the buyer.
- Time to repay: Significant improvements can be expensive. PACE loans can be paid off over extended periods of time (5-20 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 manage cash flow). Some credits are available only for the year the installation was actually completed, so you’ll want to pay all of those expenses during the same year.
Disadvantages of PACE Financing
Before using PACE funding for your project, get familiar with some of the pitfalls.
- Conflicts of interest: PACE financing often is arranged through contractors who might have an incentive to promote expensive upgrades. This can be a convenient form of one-stop-shopping, but contractors don’t know about your finances or what you can “afford”—and you can afford almost anything with a PACE loan. 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 get high-paying jobs. In addition to getting paid for the work they’ll perform, contractors might get additional referral fees from a lender if they arrange the project's funding, so the potential for conflicts of interest is real.
- Payment shock: Even if you repay over an extended 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 home loan servicer pays property taxes through an escrow account, the PACE payment might be able to be added to your monthly mortgage payment in smaller chunks.
- Interest costs: PACE funding is relatively easy to qualify for. 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 yourself depends on numerous factors, but PACE loans are not necessarily cheap.
- Costs and benefits: It’s easy to get approved for PACE programs, but is it worth it? These programs make the most sense for individuals who cannot afford less expensive loans (often due to credit problems or limited income). Projects like replacing your windows can add to your home’s value, so you should get some of that money back when you sell. However, you won’t necessarily see a substantial change in utility costs—and you’ll still have to make higher tax payments.
- Risk of foreclosure: PACE loans are secured by your home, so it’s possible to lose your home in foreclosure if you don’t make the payments. In many cases, a PACE loan moves into “first position” (in front of your mortgage lender) which means you risk foreclosure even if you make your regular mortgage payments as agreed. Other types of loans (unless they are also home equity loans) should not put you in that position.
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 need to be repaid, and there are consequences for failing to repay.
- For a good cause? It feels good to do good things, 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. Unfortunately, some property owners believe that the entire cost of a project is deductible because the payment is part of a property tax bill, and this typically is not 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 honest contractors can forget to include important details, and they don’t know about your financial situation. Get details directly from the source, and have that discussion when your contractor is not present so that 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 also can be used to 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 can delay your project, save money, and pay cash to get it done at some point in the future. Doing so 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 still may owe money when you decide to sell. In that case, you can sell the improved property, and the buyer can be responsible for repaying. The new property owner will get the assessments. 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 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.