When Fannie Mae announced its new HomeStyle Energy loan I offered colleagues an assessment that at first seemed contradictory. I suspect few borrowers are likely to use the new Energy loan to directly pay for home energy efficiency projects, yet at the same time I think the loan offers promising opportunities. Allow me to explain and to highlight how utilities could potentially take advantage of the opportunities presented.
How does the new HomeStyle Energy loan work? Fannie Mae's “HomeStyle” loans are designed to help finance home improvements. Recall that with a conventional purchase or refinance mortgage loan, the homeowner (or home buyer) can borrow up to 80 percent of a home’s appraised value. With HomeStyle, the appraiser estimates and includes the value of the proposed home improvements so the loan amount is based on the value of the house “as improved.” This allows a borrower to obtain funds needed to pay for projects that will improve the house (assuming he or she has the equity and income to support the larger loan amount).
Here's the new part: Fannie Mae will now give a $500 discount when the borrower uses the loan proceeds to make energy efficiency improvements, such as adding insulation, installing a high-efficiency air conditioner, and the like, instead of the borrower using the loan proceeds to, say, add a garage, or finish-out a basement. More details on the loan can be found in Fannie Mae’s fact sheets (e.g., what projects are eligible, when audits are required, how the discount works by reducing fees the lender otherwise would pay to Fannie Mae).
Reality check. I suspect a small number of borrowers will use this new Homestyle Energy loan to directly pay for energy efficiency projects. For existing homeowners, the decision to refinance a mortgage is usually driven by interest rates, loan balance, and fees. It probably will not make sense for most borrowers to refinance need arises to make efficiency repairs or improvements. There is a greater opportunity for people buying a homes to use the loan to fund improvements. Home buyers could use the new Energy loan to add funds for energy efficiency work or solar panels. This opportunity was emphasized in a Washington Post article on the new Energy loan. But I suspect the typical home buyer has little bandwidth to get an “as improved” appraisal to plan for efficiency work in the rush to move, and many buyers will not have additional down payment to afford a larger loan.
That might be overly negative, but let's turn to why I think the new loan is, in fact, promising and could deliver benefits in an indirect way -- a bank shot.
Indirectly funding efficiency projects. Homeowners can use the new Fannie Mae loan to pay-off prior loans obtained to fund efficiency repairs even if the prior loans are not conventional home equity loans (i.e., not secured by a lien on the real property). Consider "on-bill" loans -- a loan with regular monthly payments made through the utility bill. This is one of the most interesting ways consumers can fund efficiency work to their homes. (Here’s a full description.)
A great example is the Energy Right loan program offered by the Tennessee Valley Authority (TVA). Over 70,000 consumers -- yes, 70,000! -- have used TVA’s Energy Right loan to pay for new equipment, such as installing a high-efficiency heat pump air conditioner. TVA arranges the loan through the customer’s local power company -- electric co-operatives – and a regional lender.
I think the TVA loan is a model because it is tailored to help consumers with appliance replacement -- a prime moment to increase energy efficiency. Consider common scenarios. A heater fails, the air-conditioner breaks, or the hot water heater stops working. At these moments, the homeowner can opt for high-efficiency equipment that can have a lower total cost due to lower utility expenses. But many consumers end-up pay higher utility expenses for years to avoid paying more at the point of sale. To make matters worse, they frequently use a high-cost credit card to purchase the less efficient appliance.
A small loan from the utility to pay for a higher efficiency appliance delivers substantial value to consumers. And, all of the utility’s customers get the benefits of a more efficient utility system.
TVA’s loan is just one example. New York State offers customers several loan options for efficiency improvements, including an on-bill loan. (A list of on bill programs is detailed here.) Many cities and states also offer homeowners a loan tied to property taxes (called “PACE”), which also can be paid-off when refinancing with Fannie Mae’s Energy loan.
Here's how Fannie Mae's new Energy Loan helps. When homeowners can pay-off prior loans (such as on bill loans) routinely when they refinance or sell, utilities should have greater comfort offering these loans to their customers. Many utilities don’t offer these loans because they worry about holding consumer loans on their books for extended periods, and they don’t want to be in the posture of lender if customer cannot pay. The ability for homeowners to routinely pay-off these small loans in the mortgage process should encourage more utilities to offer such loan programs. (True, faster pre-payment might be seen differently by investors if the loans have been securitized, but that’s another subject.)
It’s also great news that Fannie Mae is actively looking for ways to help customers with energy efficiency. Fannie Mae has extraordinary reach into the housing markets and the capacity to engage in what I think of as “agile” product development – continually improving a product, such as a loan, based on how the it is used (or isn’t used), in this case by lenders and borrowers. This continual refinement is needed to craft effective solutions. More utilities and efficiency professionals should actively seek to be part of that process by working with lenders to help homeowners explore options to fund home efficiency work.