For most of 2017, the Trump Administration was quiet with regard to the Federal Housing Administration (“FHA”) loan program. However, the Department of Housing and Urban Development (“HUD”) recently offered some relief to lenders and servicers of FHA-insured loans. Through Mortgagee Letter 2017-18, HUD ended its policy of allowing FHA insurance for mortgage loans secured by properties encumbered with Property Assessed Clean Energy (“PACE”) obligations. FHA’s new policy prohibiting PACE obligations in connection with FHA-insured loans, which becomes effective for loans with FHA case numbers issued on or after January 7, 2018, reverses Mortgagee Letter 2016-11, a short-lived Obama era policy that permitted lenders to originate FHA-insured loans involving PACE obligations.
PACE loans provide homeowners an alternative to traditional financing for energy efficient home improvements such as solar panels, insulation, water conservation projects, and HVAC systems. Instead of funding the home improvements through loans, the borrower pays through special property tax assessments. PACE financing does not follow the standard review of a borrower’s income, debt, and FICO score, but rather is based on the borrower’s equity in the home and the mortgage or property tax payment history. Many states and municipalities passed legislation implementing a PACE program and establishing their own terms and conditions for PACE loans. Homeowners voluntarily sign up for PACE financing through private companies, which often offer PACE through a network of approved dealers and installers. The PACE loan is secured by a property tax lien, often with terms of up to twenty years, which takes priority over both existing and future mortgages on the property.
Although PACE loans may promote clean energy projects, they present several issues for lenders. The priority lien status of PACE loans can erode the value of a lender’s security interest in a purchase-money mortgage. Furthermore, Mortgagee Letter 2016-11 in effect placed the responsibility of determining FHA eligibility on lenders. Before a PACE-encumbered property may be eligible for FHA-insured mortgage financing, a lender needed to conduct legal analysis to determine issues such as whether the PACE obligation is collected and secured in the same manner as a special assessment under local law, whether the property may only become subject to a lien superior to the FHA-insured mortgage for delinquent special assessment payments, and whether there are terms or conditions limiting property transfer. That requirement exposed lenders to potential indemnification and the possible risk of penalties under the False Claims Act if HUD later determined that such evaluation did not conform to HUD’s PACE requirements.
Because PACE loan underwriting has not been as heavily regulated as residential mortgages or traditional loans under the Truth In Lending Act or Home Ownership and Equity Protection Act, private dealers could use aggressive marketing tactics to sell the PACE program. Dealers are not required to make a reasonable determination of a borrower’s ability to repay a PACE loan, which could jeopardize the borrower’s ability to repay a mortgage loan. Reports of consumers receiving misleading information about PACE terms and paying higher financing amounts for PACE loans than for other financing options could also increase the risk of borrower default.
Additionally, for FHA-insured loans encumbered by PACE obligations and sold into Ginnie Mae pools, HUD requires loan servicers to advance PACE loan payments, as they must with property taxes and insurance, when a borrower makes late payments, becomes delinquent, or the encumbered property enters foreclosure. Those servicer advances are not recouped until the borrower reestablishes current payments or HUD pays the FHA insurance claim, which results in higher servicing costs for such loans.
Given those issues, the FHA’s concerns about the potential for consumer abuses associated with the PACE program, and the potential for increased losses to the FHA Mutual Mortgage Insurance Fund due to PACE loans’ priority lien status, HUD’s decision to reverse its allowance of PACE obligations in connection with FHA-insured loans comes as an early Christmas gift for FHA participants.