The Pitfalls of Green Mortgages in California
At first blush, green mortgages in California seem like the perfect way to finance energy-efficient improvements and upgrades for your home. There are many benefits to green mortgages, but there are also dangers lurking within that not every sales pitch is quick or clear to disclose to homeowners. The umbrella under which these types of financing fall is called by the acronym PACE, which stands for Property Assessed Clean Energy, but you can have a PACE assessment secured to your home without ever hearing the term PACE.
That's because when the PACE programs originate with public entities, they are often administered by private entities that use another name such as HERO or Ygrene or California First. These are all examples of PACE green mortgages in California. The appeal of these green mortgages is easy to understand when you see the enormous benefits offered to homeowners.
How Do PACE Green Mortgages Work?
The first benefit is no down payment. The PACE programs offer 100% financing with little to no credit checks. Payments are not handled in a typical mortgage fashion because the green mortgage lien is attached to a homeowner's local property tax bill and dressed up as an assessment.
Pace green mortgages allow for instant financing through approved vendors for construction purposes involving energy-efficient home improvements or renewable energy installations such as dual pane windows, HVAC systems, water systems, or the upfront cost of solar panels, and more.
The Drawback to PACE Green Mortgages
Sometimes, during the excitement of adding energy efficient upgrades to the home, and the relative simplicity of obtaining these types of loans, homeowners forget to shop for the best prices. Some owners do not know the difference between a $20,000 window upgrade or a $40,000 "enhanced" window upgrade.
Since there are no out-of-pocket costs and the entire project is financed through property tax payments, comparison shopping might fall by the wayside.
The main drawback, however, is not paying too much, although that is a very real concern. The basic problem is homeowners are often promised the lien is assumable by a new buyer, in the event the homeowner elects later to sell the home, and this is not really true. For example, if a new buyer agrees to assume the cost of the improvements, and few are willing, the buyer will not be able to secure a loan to buy the home -- not through Fannie Mae nor Freddie Mac nor VA or FHA loans. The financing is not assumable if the buyer is using conventional or government financing to buy the home because the banks will not allow it.
The Federal Housing Financing Agency (FHFA) will not allow assumption because the green financing is part of the property tax bill, which is considered a superior lien, meaning it would take precedence in the event of a foreclosure and be paid first and prior to the existing mortgages. Lenders do not want another entity to obtain superior status and be placed in front of an existing loan.
This means in order to sell to another buyer who is financing the purchase, the homeowner would need to pay off the PACE loan in full.
To add insult to injury, the payoff might contain a prepayment penalty, too. Of course, a prudent homebuyer who would pay cash, for example, would probably insist that the homeowner discount the price to allow for eventual repayment of the PACE loan. So, the homeowner can't really win or come out ahead in this game in the event of resale, regardless of how the program is presented to the homeowner.
It Is Easy to Forget About Green Mortgages in Property Taxes
Many homeowners just pay the tax bill when it arrives twice a year or else the loan is impounded and payments are made monthly, in addition to principal and interest. Often, the lien does not readily show up or it appears as a tax assessment, which is easy to dismiss by mortgage loan officers and even some underwriters. A lender mentioned a file to me recently that had a credit inquiry in the seller's credit check, which was made a few months before the seller had decided to list the home for sale.
Since the inquiry was made within the past 60 days, the mortgage loan officer asked about it, just to make sure the homeowners did not take on additional debt by financing a car or another major purchase.
It turned out the homeowners had an $18,000 (8.25% interest, 20-year) PACE loan. There was no mention of the loan in the tax lien records nor in the title company's property profile. It was not reflected in the list of assessments on the current tax bill. The lender obtained a copy of the preliminary title report and as an exception was the following statement:
7. Assessments and other matters for the County of Sacramento as contained in a document entitled "Payment of Contractual Assessment Required" and/or "Notice of Assessment" (California HERO Program) recorded XX/XX/XXXX as Document No. book XXXXXXXXX, Page XXXX of Official Records. Any Assessments associated with the above document are collected with the annual taxes.
To an untrained eye, this appears to be just another assessment. But it is evidence of a PACE loan that must be paid in full at closing by the seller.
This is not to say that PACE loans or the HERO Program are all bad because that would not be true. There are many benefits to the programs, and it helps homeowners to make improvements they might not otherwise be able to afford. But be aware that the disclosures might be inadequate to help an owner understand the consequences and fine nuances of these loans which, if known, might be enough to make the homeowner pass on green mortgages.