The Federal Housing Administration (FHA), part of the executive branch’s Department of Housing and Urban Development (HUD), recently issued guidance on PACE financing programs (read the full press release here). The FHA provides mortgage insurance on loans made by FHA-approved lenders that meet specific qualifications for single family and multifamily homes and hospitals. FHA insurance provides lenders with protection from losses resulting from a property owner defaulting on their mortgage. PACE financing uses voluntary special tax assessments to secure financing for improvements on residential and commercial properties, such as energy or water efficiency improvements or solar panels. PACE assessments are repaid through the property tax bill using the same collection mechanism as other special tax assessments (generally seen as a line item on your property tax bill).
One issue that has arisen with this financing model is the priority of PACE assessments and mortgages in case of default; in other words, which debt would be in line to be repaid first in a default situation. The FHA’s guidance treats PACE obligations like a property tax assessment (as opposed to a competing loan) that only has priority or ‘prime’ status over the FHA mortgage lien for the delinquent portion of a PACE assessment – as opposed to the entire obligation of the PACE assessment – should a default occur. This decreases the risk to the mortgage insured by FHA by preventing the PACE assessment from having a superior claim to the mortgage for the full amount of the PACE assessment should a default and foreclosure occur on the property. Additionally, PACE assessments can remain on the property should a sale or transfer occur fulfilling one of the original ideas behind PACE, that the cost and benefit are tied to the improved property. This guidance now allows property owners that qualify for FHA insured loans to access PACE financing without violating the terms of their mortgage agreement (unlike loans regulated by the Federal Housing Finance Agency (FHFA) explained below) and signals the first federal action supporting PACE.
The issued guidance is part of the Obama administration’s Clean Energy Savings for All Initiative in which multiple executive branch actions and programs seek to increase access to renewable energy and energy efficiency financing for low- and moderate- income families (read the full press release here). Since the FHA guidance increases the number of borrowers who can access PACE financing, the FHA guidance expands the potential market place for PACE providers. In 2015, FHA mortgage products composed about 22% of mortgage originations at purchase, 13% at refinancing, and 18% of the overall mortgage market.
Below is a summary of the guidance changes from FHA.
Outstanding PACE Obligations
Properties which will remain encumbered with a PACE obligation may be eligible for FHA-insured mortgage financing, provided that the mortgagee determines that the following requirements have been met:
- Under the laws of the state where the property is located, the PACE obligation is collected and secured by the creditor in the same manner as a special assessment against the property;
- The 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 shall not be subject to an enforceable claim (i.e., lien) superior to the FHA-insured mortgage for the full outstanding PACE obligation at any time (i.e., through acceleration of the full obligation.) However, a notice of lien for the full PACE obligation may be recorded in the land records;
- There are no terms or conditions that limit the transfer of the property to a new homeowner. Legal restrictions on conveyance arising from a PACE obligation that could require the consent of a third party before the owner can convey the real property are prohibited, unless such provisions may be terminated at the option of, and with no cost to, the homeowner;
- The existence of a PACE obligation on a property is readily apparent to mortgagees, appraisers, borrowers and other parties to an FHA-insured mortgage transaction in the public records and must show the obligation amount, the expiration date and cause of the expiration of the assessment, and in no case may default accelerate the expiration date; and
- In the event of the sale, including a foreclosure sale, of the property with outstanding PACE financing, the obligation will continue with the property causing the new homeowner to be responsible for the payments on the outstanding PACE amount.
Disclosure of PACE Obligation, Terms and Conditions upon Sale
For properties with existing PACE obligations, the property sales contract must indicate whether the obligation will remain with the property or be satisfied by the seller at, or prior to closing. Where the obligation will remain, all terms and conditions of the PACE obligation must be fully disclosed to the borrower and made part of the sales contract between the seller and the borrower.
Where energy and other PACE-allowed improvements have been made to the property through a PACE program, and the PACE obligation will remain outstanding, the appraiser must analyze and report the impact on the value of the property, whether positive or negative, of the PACE -related improvements and any additional obligation (i.e., the PACE special assessment).
Contrary Guidance Remains in Effect from the Federal Housing Finance Agency for Residential Properties with Fannie Mae or Freddie Mac Mortgages
Importantly, there still remains contrary guidance from the Federal Housing Finance Agency (FHFA) on PACE financing for residential properties from July 6, 2010. The FHFA regulates Fannie Mae and Freddie Mac, which collectively own or guarantee more than half of the residential mortgages in the United States, as an independent conservator. Current guidance does not allow PACE assessments with superior lien status to mortgages underwritten by Fannie Mae or Freddie Mac. Residential property owners that voluntarily place PACE assessments on their property may violate the terms of their mortgage. Current PACE provider industry practices use disclosures and affirmative acknowledgment of this risk to address this issue. In practice, PACE assessment are paid in full when a property is sold or refinanced, in effect eliminating the risk to Fannie Mae, Freddie Mac, and the FHFA.
The FHFA’s status as an independent entity means that it is not subject to executive branch control (it is overseen by Congress) and consequently outside the Obama administrations Clean Energy Savings for All Initiative that led to the FHA guidance. You can read more about the history of PACE and the FHFA guidance (see chapter 5) in our Residential and Commercial Property Assessed Clean Energy (PACE) Financing in California Rooftop Solar Challenge Areas report.