Property Assessed Clean Energy (PACE) Lending Presents Serious Consumer and Industry Risks
MBA believes that energy efficient home improvements can be beneficial for homeowners; however, MBA has significant concerns with the PACE program construct and the risk it poses to traditional lien priority. Moreover, recent moves by the Federal Housing Administration (FHA) to permit PACE financing ahead of an FHA mortgage amplify critical concerns about PACE's lack of consumer protections, the increased risks to the Mutual Mortgage Insurance (MMI) Fund, and the significant compliance and indemnification risks for lenders and servicers.
- PACE programs have been implemented in jurisdictions throughout the country, and their exact structure, terms and conditions vary by program, state and municipality. Energy improvement and water efficiency products available for financing also vary-ranging from solar panels to energy efficient appliances, windows, etc.
- Typically, private companies initiate PACE loans by approving a contractor to make these energy improvements, often funded by proceeds raised through the issuance of municipal bonds.
- A borrower's PACE loan payments are added to their property tax bill as a special assessment, to be typically paid over 5 - 25 years.
- The PACE loan's integration with property taxes effectively grants a priority status over both existing and future mortgages, thereby undermining the collateral position of the first mortgage.
- The outstanding PACE loan obligation typically runs with the property, not the borrower.
- Given the repayment of PACE loans through the tax structure, delinquent PACE amounts may become senior in lien priority to prior recorded mortgages. This concern and others spurred the Federal Housing Finance Agency (FHFA) in June 2012 to prohibit Fannie Mae and Freddie Mac (the GSEs) from purchasing mortgages where the property has a PACE loan attached. FHFA clarified this position again on December 23, 2014, in a statement asserting that the GSEs may not purchase single-family home loans that are subject to a primary lien assessed through a PACE lending program.
- On July 19, 2016, FHA issued Mortgagee Letter 2016-11, which for the first time permits FHA financing to purchase or refinance properties with energy-related home improvements attached, financed through a PACE program.
- The Department of Veterans Affairs simultaneously released its own PACE guidance, Circular 26-16-18, which is parallel to FHA's guidelines.
PACE Compatibility With FHA-Insured Financing:
- FHA has established the following requirements that must be met in order for a property to be eligible for FHA-insured financing with a PACE loan obligation:
- A PACE obligation must be collected and secured by the creditor in the same manner as a special assessment against the property.
- A property may only become subject to an enforceable claim (i.e., a lien) that is superior to the FHA-insured mortgage for delinquent regularly scheduled PACE special assessment payments. The property may not be subject to an enforceable claim superior to the FHA-insured mortgage for the full outstanding PACE obligation at any time; however, a notice of lien for the full PACE obligation may be recorded in the land records.
- There can be no terms or conditions that limit the transfer of the property to a new homeowner.
- The existence of a PACE obligation on a property must be readily apparent in the public records and must show the obligation amount, the expiration date, and cause of the expiration of the assessment. In no case may default accelerate the expiration date.
- A property with an outstanding PACE obligation, in the event of the sale (including a foreclosure sale), will continue with the property causing the new homeowner to be responsible for the payments on the outstanding PACE amount.
- For properties with existing PACE obligations, the sales contract must indicate whether the obligation will remain with the property or be satisfied by the seller at or prior to closing, and all terms and conditions of the PACE obligation must be fully disclosed to the borrower and included in the sales contract.
- Where energy and other PACE-allowed improvements have been made to the property, and the PACE obligation will remain outstanding, the appraiser must analyze and report the value of the property of the PACE-related improvements and any additional obligation (i.e., the PACE special assessment) on the value of the property.
- These policies are not applicable to FHA Home Equity Conversion Mortgage (HECM) or Title I Loans.
- Note: This FHA policy is effective immediately. Members are encouraged to review Mortgagee Letter 2016-11 and updates to FHA's Single Family Housing Policy Handbook 4000.1 with counsel and appropriate compliance staff.
- Risks for Participating Lenders and Servicers:
- Lenders are responsible for determining if a PACE program is compliant with FHA's guidelines. Therefore, PACE program eligibility is structured as a lender warranty, circumscribed by general requirements and standards that PACE programs must meet to be eligible for FHA financing. This framework could expose lenders to both indemnification and False Claims Act risk due to the lack of standardization that exists among PACE programs across the country.
- Lack of Consumer Protections:
- PACE loans do not offer the disclosures typically associated with real estate financing. As a result, homeowners may not fully understand the consequences of assuming an increased financial obligation on their tax bill. These borrowers also may not be able to effectively compare the cost of a PACE loan to that of more conventional financing (such as home equity lines of credit (HELOCs) or second mortgages).
- PACE financing is generally based on the property's tax capacity, rather than on the borrower's ability to repay. Notably, PACE loans are not covered by the CFPB's Ability to Repay rule. These loans also typically carry interest rates far higher than conventional mortgage loans-often ranging between six and ten percent. This may allow borrowers to assume an obligation that significantly increases their property tax payments even if they are not financially equipped to make the new payment.
- Increased Loss Severity to FHA's MMI Fund:
- FHA has not removed lien priority concerns by simply indicating that a PACE loan is a tax assessment. Due to this categorization, PACE obligations will still have priority over previously recorded liens, and more specifically FHA guidance still allows a property to become subject to a lien superior to the FHA-insured mortgage for delinquent PACE loan amounts.
- FHA has not provided appraisal guidance or standards for the evaluation of energy efficient home improvements under PACE. Yet appraisers are required to analyze and report the impact of PACE energy improvements on the value of the property. This poses a risk that improvements or cost savings may be overvalued, as benefits are often difficult to quantify.
- Remaining PACE obligations may impact the salability of the FHA-insured property. With the outstanding PACE loan obligation running with the property, borrowers who later sell may find themselves having to pay off the outstanding PACE loan per buyer demand, or agreeing to a lower sales price. In some cases, borrowers may find themselves underwater, precipitating a default and a claim on the MMI Fund. Moreover, in the event of a foreclosure, the presence of the PACE obligation could result in the property being sold at a discount. As a result, the FHA insurance will ultimately take a hit.
MBA's Position / Next Steps:
- MBA has asked the Consumer Financial Protection Bureau (CFPB) to intervene on PACE's significant consumer protection issues and continues to urge FHA to slow implementation and engage with industry and consumer groups to address many of the problematic aspects of its PACE guidance.
- MBA believes the best way to address PACE program consumer protections is through a formal regulatory framework that ensures PACE loans have the same protections as other home improvement financing options secured by a mortgage under the federal mortgage rules. MBA strongly recommends that PACE obligations be classified as consumer credit transactions secured by a dwelling, to ensure that borrowers are covered by federal consumer protection laws, as are the entities that originate PACE loans.
- MBA urges members to carefully review the consumer and lender risks before participating in this program and encourages members to evaluate alternative means to help consumers finance energy efficient improvements that better protect consumers at lower costs, including existing home equity products and recent energy efficiency products released by the GSEs.
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