I have been blogging repeatedly on the value to the economy of reforming mortgage underwriting rules to account for the better loan performance of energy efficient and location efficient homes. A new study supported by the Institute for Market Transformation and carried out by the University of North Carolina released this week reinforces this idea definitively.
The study, Home Energy Efficiency and Mortgage Risks, finds that “default risks are on average 32 percent lower in energy-efficient homes, controlling for other loan determinants. This finding is robust, significant, and consistent across several model specifications... Within ENERGY STAR-rated homes, default risk is lower for more energy-efficient homes.” This is the first study of its kind and is based on a sample of 71,000 home loans from across the country.
The findings of the analysis show that energy costs are significant, but they are still smaller than the purchase price of a typical home: for the average home in the study, the loan payment cost was roughly $200,000. In comparison, average energy costs are $75,000 over 30 years.
But in trying to explain the better loan performance of the energy efficient homes, we observe that the difference in energy costs between an efficient home and a typical home is only 15 percent of the $75,000 energy costs – or about $11,000 –since the ENERGY STAR specification for its new homes program requires 15 percent energy savings.
Would anyone have predicted that a difference in cash flow of $11,000—or about 4 percent of the total loan payments and energy costs (that is, $200,000 for loan payments and $75,000 for energy, before the ENERGY STAR savings)—could make as big a difference as 32 percent in default rate? I would have expected that if we reduced energy costs plus home loan payments by 4 percent, mortgage defaults may go down by 2 percent or so. Instead, according to the analysis, we observe a 32 percent decline.
We would also expect that such a small relative difference in total costs would yield a reduction in defaults that is too small to be statistically different. It is very hard to find the effects of small changes in an explanatory variable on an observed outcome with statistical confidence unless your sample is a lot larger than 71,000 loans. But instead the study finds otherwise.
To make our point more clear, if a $11,000 savings in energy could lower the default rate of a $200,000 loan by 32 percent, we can only imagine how much a 50 percent savings in energy and transportation costs worth over $200,000 might do!
I recently blogged that there is evidence suggesting that some one-third of mortgage defaults were caused by the failure of both for Fannie Mae and Freddie Mac to consider systematically the costs of transportation and energy in determining whether a household qualifies for a loan.
This new University of North Carolina study suggests that the true figure for the number of defaults that could have been avoided is far higher than one-third.
It also emphasizes that mortgage underwriting reform is urgently needed to protect the integrity of mortgage-backed securities without increasing government spending to fund a continuing bailout to the investors in failed mortgages. It would be irresponsible for Fannie Mae and Freddie Mac to ignore this evidence.