Energy-Efficient Homes: How Do They Affect Mortgage Risks?
An investment in energy-efficient home systems and appliances will pay for itself long-term. Unfortunately, many buyers can’t enjoy the benefits of an energy-efficient home because of mortgage financing hurdles. Currently, mortgage pricing and underwriting flexibility do not reflect the savings that energy efficiency brings. If they did, more homeowners might invest in making their home energy efficient, which may ultimately be a benefit to lenders as well.
According to a study performed by the Institute for Market Transformation (IMT), borrowers in an energy-efficient home tend to have lower default and prepayment risks. For default, which is when the borrowers stop making scheduled payments for a period of time, the risks were found to be 32 percent lower in homes that were energy-efficient. Similarly, prepayment, which is when a homeowner pays off the loan early, is 25 percent less likely in an energy-efficient home.
While prepayment is good for the borrower, it can often lead to the lender acquiring less total payment than expected because of the reduced time accruing interest. Since each risk is substantially lower in energy-efficient homes, lenders may want to consider this impact when underwriting mortgages.
How Lenders Can Support Energy-Efficient Investments
Lenders can encourage buyers to make energy-efficient investments by offering benefits in exchange for the lower risks that come with these types of properties. Providing more flexibility in underwriting creates a competitive advantage for lenders, both for new loans and those needed for improvements to an older house.
One way lenders can offer support for energy-saving investments is to use energy-efficient mortgages (EEMs). These give lenders flexibility in additional underwriting factors, such as debt-to-income, which may allow borrowers to qualify for lower interest rates and larger loans, even with moderate income. Additionally, EEMs let buyers finance efficiency features at mortgage rates instead of the elevated rates of commercial credit.
Another action lenders can take to foster energy efficiency is to require an energy audit or rating while underwriting the loan. This can lead the homeowner to make more informed decisions and a have a better understanding of investments in energy efficiency, which could result in sustained efficiency long-term.
Lastly, a lender can use energy efficiency as collateral for the loan in an underwriting decision. For example, buyers may get a higher appraisal value for the home if there are energy enhancements. That could result in borrowers enjoying more underwriting flexibility, which may mean the extra cost for making the house more energy-efficient could make it more affordable for the middle-class buyers in high-cost areas.
In addition to the lowered risk, the IMT study suggests owners of efficient homes more commonly meet their mortgage responsibilities. Even though these benefits are considerable, current mortgage underwriting procedures do not account for this. But it might be worthwhile for lenders to adjust their practices and push more buyers toward energy-efficient homes.