Why would you loan money to someone without fully assessing the likelihood of being paid back? Lenders do make such loans on occasion – student loans, for example.
Property Assessed Clean Energy (PACE) loans are another example of loans that don't take credit history into account. PACE loans have one other aspect in common with student loans – default rates are on the rise.
PACE loans are designed to help homeowners finance environmentally conscious home upgrades such as solar panels and energy-efficient HVAC systems. Since they require no credit checks and can completely fund a project without requiring any down money, PACE loans are very attractive to lower-income homeowners who would not otherwise qualify for upgrades.
The same properties that make PACE loans attractive can make them dangerous to homeowners that do not fully understand them. Through analyzing tax data in 40 California counties, the Wall Street Journal found that defaults on PACE loans increased by more than a factor of four over the past 12 months, at nearly 1,100 compared to 245 defaults one year ago.
Because of the structure of PACE loans, default can have significant consequences that can catch borrowers by surprise. PACE loans are considered as assessments attached to properties; thus, they are incorporated into your property tax bill instead of being lumped into a mortgage payment. They generally take precedence over your mortgage, meaning that you can be up-to-date on your mortgage payments yet potentially lose your home by defaulting on the PACE loan.
Another side effect of PACE loans is that local governments must deal with PACE defaults instead of lenders, since a PACE default is essentially a failure to pay taxes. This can leave governments with the unwanted burden of recouping the loan amount through seizure and sale of homes.
PACE loans range anywhere from $5,000 to more than $100,000, with the average loan amount at approximately $25,000. Even without missing the two consecutive payments that will put you fully in default, running an unpaid balance can be financially painful. Additional interest on unpaid balances accrues at 18% annually. Late payments will also hurt your credit score for years to come. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
The popularity of PACE loans has at least as much to do with investors as it does with homeowners. Bonds that are backed by PACE loans have a yield around 4% – quite appealing in the current bond market – and because of the hierarchy of PACE loans, PACE lenders are paid before mortgage lenders in case of default. That gives PACE-backed bonds an unusual safety factor for their yield.
We have previously written about the potential dangers of PACE loans for this very reason – they are inherently risky loans that investors love to own packaged as securities. They are unlikely to cause a full-blown economic crisis (as with subprime mortgage loans) because of smaller overall volume and risk tilted away from investors, but individual homeowners who don't set aside funds for PACE payments in their property taxes can suffer their own personal economic crisis.
PACE loans can certainly play a valuable role in promoting green energy, but it's important that you fully understand how PACE loans work before entering into one. Realize that PACE loans carry a different style of risk, and that interested parties have significant incentive to talk you into accepting one.
Our advice with PACE loans is the same as it is with any mortgage loan – don't be tempted to take out more money than you can afford to pay back just because someone will loan it to you.
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