Every day, thousands of Americans make the biggest purchase they’ll make in a lifetime—their home—without knowing the true cost. In spite of stringent post-recession safeguards intended to protect homeowners and hold lenders to a higher level of accountability, there’s more we can do.
Right now, there is an unprecedented opportunity to transform the mortgage industry for the better, ensuring lower-risk loans for lenders, and higher-value, better-quality, and more equitable homes for homeowners. Legislation, regulation, and market forces are all aligning to appropriately take into consideration energy consumption in mortgage underwriting.
The typical American family spends more than $2,500 per year on energy bills. Utility bills are a major household expense, typically greater than either real estate taxes or homeowners insurance. But they are currently not included in home appraisals or mortgage underwriting. This puts homeowners at risk of not being able to afford both mortgage and utility payments, and puts lenders at risk of higher default rates. A study by the Institute for Market Transformation (IMT) and the University of North Carolina found that energy efficient homes had a rate of default 30 percent lower than standard homes.
Energy efficient homes create jobs and improve financial stability, the environment, and occupant health. That’s why homebuilders, manufacturers, appraisers, environmental organizations, and parties on both sides of the aisle support updating the mortgage underwriting process to account for home energy performance.
The Sensible Accounting to Value Energy Act (SAVE Act) amendment, which the Senate recently passed, encourages mortgage lenders to incorporate home energy savings when determining the affordability of a home.
Specifically, the SAVE Act directs the Department of Housing and Urban Development (HUD) to issue guidelines for the Federal Housing Administration (FHA) to account for the expected energy cost savings in determining the debt-to-income ratio and loan-to-value ratio. As a result, high-performing homes will be appraised at a higher value and be more affordable to the homeowner—with no cost to taxpayers.
The SAVE Act has gained support from a diverse group of organizations, including the National Resources Defense Council, the National Homebuilders Association, the National Association of Manufacturers, and the U.S. Chamber of Commerce because they recognize the economic opportunity. Other industries saw the benefit of creating 50,000 or more jobs and generating an estimated $1.1 billion in energy savings.
Cliff Majersik, executive director of IMT and a member of the SAVE Act Coalition, explains the act’s appeal to industry: “Leading home builders were already building more efficient homes—and yet energy efficiency was not factored into the appraised value of the home, or mortgage underwriting—significantly cutting into their profit margins. If the SAVE Act were in place, more families would be able to afford these homes, and homebuilders would be motivated to go further.”
The SAVE Act goes a long way in ensuring the accurate accounting of efficiency in determining the affordability of a home—but it can go even further. Currently, the SAVE Act applies only to homes insured by the FHA, which represent roughly 10 percent of new mortgages annually, or nearly five million single-family homes, but it could be applied to the broader market. “If the SAVE Act guidelines are good for FHA loans, they are good for all loans. Simplicity and standardization help the market move together toward one outcome,” says Majersik.
In addition to legislation, regulation and other market forces are also aligning to transform mortgage underwriting. In December 2015, the Federal Housing Finance Agency (FHFA) released its proposed Duty to Serve rulemaking. Duty to Serve would require Fannie Mae and Freddie Mac to address energy efficiency in mortgage underwriting guidelines for low- and moderate-income families and first-time homebuyers in underserved markets—the ones who need it most (as low-income customers can spend as much as 20 percent of their monthly income on utility bills).
Taking into account home energy performance when underwriting low- and moderate-income mortgages not only enables underwriters to comply with their safety and soundness requirements through the FHFA, but also provides these homeowners equitable access to higher quality homes. This improves the likelihood of upward mobility for these families because their homes can better maintain or improve in value.
Now the FHFA is working to determine just how energy efficiency plays a role in protecting and serving underserved markets. An insight brief coauthored by Rocky Mountain Institute and IMT describes the opportunity to transform the underwriting process through Duty to Serve and other means.
Key market trends indicate that energy efficiency is gaining traction, independent of legislative and regulatory action. Homebuyers are becoming savvier about the benefits of high-performance homes, and homebuilders are building more efficient homes. Real estate agents and appraisers are looking for new ways to incorporate home energy performance into the value of a home and into their sales pitch. The congressionally chartered Appraisal Foundation recently came out with guidelines for high performance housing; the Appraisal Institute has developed addendums to appraisals for green homes; and the National Association of Realtors has developed a green multiple listing service.
As the recession showed, it’s beyond time to move toward more rational underwriting processes to enable financial stability and ensure affordability for homeowners. Taken together, the SAVE Act amendment, FHFA’s Duty to Serve rulemaking, and key market trends could truly transform the real estate market for the better.