Residential Energy Efficiency and Mortgage Financing

The following article is from the current issue of Carolina Banker magazine written by Marshall Dunlap. He is a residential green building specialist for the NC Solar Center and the NC Energy Efficiency Alliance. To view the complete magazine, click here.

Utility payments represent a significant yet underappreciated slice of the average homeowner’s budget. These heating, cooling and other energy related expenditures accumulate over the lifetime of every home. Despite this substantial long-term financial liability, traditional mortgage lending practices fail to take into account the degree to which a home’s energy efficiency can significantly impact the borrower’s ability to service his or her mortgage debt. This failure is a lost opportunity for lenders, homeowners and by extension, the American homebuilding industry.

According to figures quoted by the institute for Market Transformation, in 2008 the average American homeowner spent $2,278 to heat, cool or otherwise keep the energy flowing in his or her residence. By comparison, that same average homeowner spent $1,879 on property taxes and $791 on homeowner’s insurance in the same year. Taxes and insurance, along with the principal and interest in a mortgage loan, are routinely accounted for by lenders in determining the amount that a borrower can afford. Why not energy costs?

Traditional mortgage lending treats energy expenditures as if they were a predictable and discretionary component of a household budget. it is assumed that – like food, transportation, and entertainment – these costs can be reduced if necessary in order to pay the mortgage. This presumption is inaccurate in many ways.

Some occupant behavior, like adjusting the thermostat and taking shorter showers, can indeed reduce a home’s energy consumption. But a household’s energy costs are largely determined by the building’s construction details and the efficiency of its equipment and other building components. These factors can vary significantly from home to home, and the failure of lenders to recognize this variance when writing a mortgage means that a considerable portion of a borrower’s monthly expenses are not accurately considered in determining what size home loan he or she can afford.

A modest investment in energy efficiency features during the construction of a home can typically result in a reduction of 30% or more in energy costs. Applying this to the $2,278 average annual energy expense quoted above would account for $683 in annual savings. Over the life of a standard 30-year mortgage serviced on this home, even the simple accumulation of these savings amounts to over $20,000. For the homeowner, these savings could be applied instead to mortgage payments and other investments. For lenders, this translates into a more attractive client to finance.

The first and most straightforward approach to ensuring energy efficiency in a home being built or purchased is to look for the ENERGY STAR ® label. ENERGY STAR homes incorporate high performance windows, tight envelope construction and duct systems, effective insulation and efficient equipment and appliances. Underscoring all of these strategies is a system of third-party verification by independently certified energy raters.

The cost of implementing measures capable of achieving a 30% reduction in energy consumption varies, depending on the size and design of the home, its site conditions, the experience of the builder and many other factors. But data shows that with careful planning and engagement of a qualified energy rater and a responsible homebuilder, $2,000-$3,000 of additional investment can meet this goal. A conservative analysis demonstrates that the initial investment required to reduce a home’s energy costs by $450 annually can add roughly $100 per year to the mortgage payments. Energy efficiency is an investment that offers payback from the moment the lights are turned on.

So why should lenders care? Lower homeowner utility bills mean that more money is available to pay the mortgage. A green, energy efficient home is generally built better and more durable, and therefore less likely to incur unexpected maintenance costs. With properly designed fresh air ventilation, it will also have better indoor air quality, making it less likely to promote health problems and their financial burdens arising from “sick building syndrome.” Finally, recognizing the financial asset of energy efficiency in the home and the resulting enhanced ability of the homeowner to afford a mortgage increases the lender’s ability to safely lend to less risky borrowers.

Mortgage lenders should embrace the opportunity to offer Energy Efficient Mortgages – loans that recognize that the homeowner will spend less on utility bills and can thus afford larger mortgage payments which service the initial investment in energy efficiency upgrades. investing in high-quality, efficient ENERGY STAR homes offers payback for everyone involved.