Property Assessed Clean Energy (PACE) loans are in the midst of controversy. Are they an effective way to incorporate more green energy into homes, or are they planting the seeds of the next housing crisis? Both statements may apply.
PACE loans are designed to finance home projects involving renewable energy and energy efficiency. While the program is federal, it is implemented through state laws and local programs that tailor the loan program toward local needs. The loans are popular because they can fully fund projects (meaning no money down) and do not take credit history into account. Thus, the loans are relatively easy to get — and also potentially very risky.
Why is credit history not considered? PACE loans are tied to the property, not to the property owner. Borrowers are assessed by their home equity. You can still receive a loan with sufficient home equity but questionable ability to pay based on current income and expenses. According to Realtor.com, PACE loans can range anywhere from $5,000 to over $100,000 with interest rates in the 6% to 9% range and a repayment period of 5 to 25 years.
Since loans are related to the property, there are several other aspects of the program that may catch homeowners by surprise. The PACE loan is similar to a second mortgage — but typically, it takes precedence over your primary mortgage. That means failure to pay your PACE payment can result in a lien being placed on your home even with up-to-date mortgage payments.
Because the loan is attached to the property, the loan obligations (and any liens) are transferred to any future buyer. Home sales become considerably more difficult under these conditions.
Also, because of the attachment to the property, payments on PACE loans are typically considered an assessment and added as a lump sum to your property tax bill. That mechanism catches many homeowners by surprise and can leave them short of the necessary funds to pay the bill.
PACE loans have grown from a negligible number in 2012 to $3.4 billion in 2016, according to The Wall Street Journal. Growth is not necessarily coming from demand from homeowners, but more from demand for bonds backed by these loans. These bonds have high ratings and decent payouts, and are backed by environmentally friendly practices.
However, since they are tied to the property and associated with building or renovation projects, PACE loans tend to make contractors into a form of loan broker — with a vested interest in pushing the loan through, and potentially with limited training and ability to properly explain the terms and risks to consumers.
The PACE program has a low default rate at this point. The Kroll Bond Rating Agency notes that default on securitized PACE loans is below 1%. However, just as in the subprime housing crisis, the conditions are ripe for future problems. The current system is likely to produce more future defaults based on PACE loans' explosive growth, unique structure, and form of risk assessment. Because the program is relatively new, bond agencies don't have enough history to forecast future default rates accurately — thus risk may be significantly understated.
Before taking out a PACE loan, make sure you fully understand the conditions and the structure of payment obligations. Compare the PACE loan to more conventional loan options for which you qualify, and review your state laws regarding PACE. Do not take a contractor's word on the PACE program without doing independent research on how it will work for you.
As an investor, realize that the risk may be understated on bonds backed by PACE loans, and keep an eye on default rates. If banks end up with a large increase in foreclosed homes and a corresponding decrease in PACE loans that are in good standing, look out. That is a disturbing parallel to the unraveling of mortgage-backed securities that precipitated the housing crisis. Invest if you like, but protect yourself by going beyond the bond ratings to review the PACE program's stability.
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