— A Market Insights Guide To PACE Loans —
PACE Loans: Is This Really The Next Subprime Crisis?
by Chris Brown, President, CB Investments
25 July 2017
PACE Loans are designed to give homeowners new ways to finance energy efficient home improvements.
“America’s Fastest-Growing Loan Category Has Eerie Echoes of Subprime Crisis”Kristen Grind | Jan 10, 2017
$3.4 Billion Lent Out
Fastest-growing type of financing. Execs predict it will double this year.
Plumbers & Contractors
Essentially function as loan brokers pitching loans to land contracts.
No Down Payment
The debt is added to property-tax bills as an assessment.
Do you see a problem here?
My introduction to these loans happened a couple years back when a borrower tried to refinance, but could not do so using a conventional Fannie Mae or Freddie Mac mortgage. It then happened a second and third time… With all the borrowers, they were completely shocked that this would affect their ability to refinance their mortgage and substantially improve their financial situation. Furthermore, they were quite surprised that this could affect their ability to sell the home in the future.
So what is a PACE loan anyway? PACE loans, which stands for Property Assessed Clean Energy, provide financing for homeowners who want to purchase and install eligible energy savings products (think solar panels, energy-efficient windows, LED lighting, low flow water valves, HVAC retrofits). While the national program began in 2009, it did not really blossom until 2016. Since its inception, over $3.4 billion in loans have been made, but $2.8 billion of this was in 2016 and it is expected to double this year.
Can anyone get a PACE loan? The simple answer is no. These programs which were developed at the Federal level by the Department of Energy require each state to adopt its usage. To date, 34 states and Washington D.C. have passed legislation allowing these PACE loans. From here, each local county government has to enact law to allow these PACE loan payments to be collected with their property tax bills. Riverside County, CA was the first jurisdiction to do so and by far, there are more PACE loans being done in California than any other state. Some states and counties have refused to pass this legislation as they were afraid of the mortgage financing implications.
Loans average about $25,000, and charge interest rates of 6% to 9% over a repayment period of usually five to 25 years.
PACE loans generally range from $5,000- $100,000 (average size is $25,000), at a 6-9% interest rate and can be amortized up to 25 years, and are available for any homeowner with a minimum 10% equity in their home. The PACE loan combined with the home’s current value cannot exceed 100% of the post-completion value (after energy savings product installed). The IRS also recently announced that interest on PACE loans are tax-deductible.
How did this program suddenly become so popular? The companies that issue PACE loans, the largest being Renovate America and Ygrene Energy Fund, have done a remarkable job spreading the word to thousands of contractors, who then become their de facto salesforce. These contractors, who receive little to no training regarding the loans, tout these programs as subsidized by the government where the homeowner doesn’t have to pay a penny down and they can get their home renovation project paid for in its entirety. For making this recommendation, the contractor gets a referral fee from the PACE finance company and gets the job to do the renovation work, often marked up at inflated prices as the homeowner thinks it is the government subsidizing the bill.
Pros & Cons
While these loans on the surface seem to be an entirely positive step for our economy, if you are considering one of these loans, it is important to understand the pros and cons of these PACE loans. The pros are that you are able to finance 100% of the purchase and installation of eligible energy upgrades, which of course is good for the environment, as well as bringing more work to contractors doing the installations.
The cons are these PACE loans become a 1st lien priority as they are attached to property taxes, superseding mortgage liens that were meant to be in 1st lien only priority. The Federal Housing Finance Agency (FHFA), who has jurisdiction over the two US housing giants, Fannie Mae & Freddie Mac, recently came out with a ruling that they would not provide mortgage financing to homes that have PACE loans on them (exception if PACE loan originated prior to July 6, 2010). This can be problematic when homeowners try to refinance or sell.
It may seem too good to be true, until something surprising happens.
Devil In The Details
What actually happens when a PACE loan is made? After the PACE loan company executes a contract with the homeowner and money is disbursed, a deed is recorded with the applicable local county government. From here, the county administers the loan, collecting the PACE debt loan payments, along with their property tax assessment, and in turn, disburses the PACE loan repayment to the loan company. This PACE loan, as it becomes part of the county tax bill, becomes what is known as a “super lien” priority. A super lien priority is a fancy name that means this debt obligation has the very top priority, on the same level as government property taxes, and immediately trumps any 1st mortgage loan on the property.
Fannie Mae and Freddie Mac, the two government-sponsored entities that are under the jurisdiction of the Federal Housing Finance Agency (FHFA) and are the backbone of the U.S. mortgage market, recently came out with a ruling that under no circumstances would they provide mortgage financing to homes that have PACE loans on them (exception if PACE loan originated prior to July 6, 2010) as their mandate is to be only in a 1st mortgage lien position. The huge irony in this is another government agency, the Department of Energy, was whom initially promoted this program. As frequently happens with the myriad of laws and agencies that we have, there are contradictory directives coming from these Federal agencies.
To further add to the confusion, FHA (Federal Housing Administration), who is administered by the US Department of Housing and Urban Development (HUD), came out with a directive that they are okay being in a subordinate position behind PACE loans, a direct contrast to FHFA’s stance. The VA (Veteran’s Administration) also said they are okay being in a subordinate position. However, it is important to keep in mind that Fannie/Freddie loans are far more prevalent than FHA and VA loans in the US mortgage landscape.
A very confusing landscape to say the least, one in which different departments within our Federal government are seemingly contradicting one another. Furthermore, local and state governments are also unsure as to if they should administer these PACE loans as there is no clear directive on the Federal level. You can expect to hear a lot more about this in the coming months as these PACE deals become further scrutinized. That leads us to the question, “Are these loans problematic?” I can tell from first-hand experience that the handful of clients I know that went through with these PACE loans really had no idea the negative implications that could result. No contractor or internal sales rep ever told them it would affect their ability to refinance and/or sell the home. There were very little disclosures and education provided, as to this point, they are largely unregulated and do not fall under the same strict disclosure requirements of mortgage lending. This could change soon as a US Senator Tom Cotton just introduced legislation that would require PACE lenders to be regulated like mortgage lenders. I would expect this to resoundingly pass when it comes up to vote, but in the meantime, we have general contractors peddling loans with little to no oversight, not a pretty picture.
You’ve got to wonder. How soon will it take for a market correction to take place?
Under The Table
Since these loans are really just starting to become popular, there is not a lot of seasoning data on how well the loans are performing. According to Renovate America, the San Diego-based company that is the largest provider of these loans, the default rate is less than 1%. The word from their company is that Wall Street loves these loans and has a huge appetite for them. Not long after this announcement, Renovate America admitted paying off 83 loans on behalf of borrowers so it wouldn’t affect their default rates. The article went on to say that a former compliance officer of the company said the actual number of loans that were secretly paid off by the company is actually much higher. All it will take is the next cycle in the economy where home prices again fall (and it will happen!), where these PACE loans are deemed a lot riskier than currently perceived.
So are these loans really the next subprime crisis? While I think you will find that there will be a lot of problems and increased default rates on these loans once the next downward real estate cycle hits, at this point, it is only a fraction of what the subprime crisis was at its height. The PACE loans are expected to double this year to perhaps $6 billion in volume. Compare this to 2006, the year with the highest subprime originations, we had over $600 billion of subprime mortgages originated that year. Yes, PACE loans could definitely be a catalyst for other problems in the economy, but isolated by itself, will not be the death blow that the subprime crisis was.
So what is the best option for a potential homeowner that wants to do some energy upgrades and needs financing? While the PACE loan program may be a viable avenue, the homeowner should weigh all available options, including a cash-out refinance, equity line, or some new agency programs that are coming out, including Fannie Mae’s Home Style Energy Financing program. When private liens become “super liens” that are on the same footing as public tax liens, this creates a messy situation for private lienholders who are suddenly displaced of their first priority positions.
If I am a homeowner, I would not engage in a PACE loan in the current environment, whereby we have different Federal agencies giving contradictory directives. Remember, once this PACE loan is recorded, it becomes a super lien priority, which can affect your ability to refinance the mortgage and/or sell your property. I believe you will see a lot of news on PACE loans in the coming months and until then, do yourself a favor and consider other financing options.