How Energy Efficiency Enables Stable Capital Markets

A paradox currently exists in the U.S. home improvement market. While homeowners say they want energy improvements for their homes, the rate of home energy upgrades is decreasing. One study found that residential energy upgrades are the top unmet demand among U.S. households. So why aren’t more homeowners investing in energy upgrades? RMI found—after the course of hundreds of interviews with industry experts—that a combination of inconvenience and poor access to upfront capital for home energy improvements is to blame.


One of the best ways to spur investment in energy efficiency upgrades is through the availability of energy efficiency financing programs such as property assessed clean energy (PACE) financing. PACE lets homeowners finance energy efficiency upgrades through their property tax bill. While residential PACE is allowing the energy efficiency market to blossom in places like California, the rest of the country has seen limited uptake of PACE or has yet to enable this new financing product.

PACE first requires state-level implementation and then county or municipal adoption. Currently, residential PACE programs operate in only a handful of states including California, Florida, New York, Wisconsin, Missouri, Oklahoma, Vermont, and Maine. The slow adoption rate has been attributed to the mortgage industry’s unwillingness to underwrite loans in PACE-enabled jurisdictions. Mortgage backers Fannie Mae and Freddie Mac are currently unable to acquire PACE-encumbered loans. Fannie Mae and Freddie Mac purchase over 70 percent of mortgages in the secondary market and set strict underwriting requirements for loans they are willing to purchase. Therefore the market follows their lead.

That’s why the Federal Housing Administration’s (FHA’s) announcement this fall that it will underwrite residential mortgages that have existing PACE loans associated with the property as long as they are subordinate to the mortgage has made considerable waves across the sustainable finance community. Almost concurrent with the FHA’s announcement, the HERO program in California eclipsed $1 billion in residential PACE issuances despite the barriers presented by the mortgage industry to date—barriers that if overcome would catapult the PACE lending industry. The FHA is expected to release PACE program guidelines that will enable other jurisdictions considering residential PACE to design their programs in a way that does not unnecessarily hinder the issuance of new mortgages in their area. The sustainable finance community is watching closely to see if Fannie and Freddie follow suit.


A recent study published by the Institute for Market Transformation (IMT) and the University of North Carolina shows the financial services industry is missing the big picture altogether when it comes to home energy upgrades—that home energy upgrades reduce default and collateral risk significantly. The study found that homes that received home energy upgrades saw reduced default rates of over 30 percent. Simultaneously, a lurking iceberg in the real estate market exists around the condition of homes. According to Teresa Lopez of Green Energy Money, a green project planning and financing company, deferred maintenance on homes is at an all-time high, and lenders are underwriting homes where the collateral is subject to this risk. Deep home energy upgrades mitigate this issue. Therefore PACE-enabled jurisdictions might actually realize lower default risks over time.


But what if financial markets responded to energy efficiency signals such as Energy Star, PACE, or WHEEL (the Warehouse for Energy Efficiency Loans)? If underwriters considered cash-flow risks associated with energy-hog homes and their ability to expose homeowners to unnecessary energy price volatility, then perhaps they would better incentivize and price mortgages for energy-efficient homes versus high-energy-use homes. For years now energy efficiency advocates have been encouraging Congress to pass the SAVE Act, which would require all government-sponsored enterprises (GSEs), including Fannie Mae and Freddie Mac, to do just that, only to see the SAVE Act languish in committee. But what if financial markets could be reformed without needing legislative intervention? The Federal Housing Finance Authority (FHFA)—the GSEs’ regulator—offers just that through its “Duty to Serve” rule.


Following the 2008 financial crisis, Congress amended the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 requiring Fannie Mae and Freddie Mac to serve three underserved markets in order to increase the liquidity of mortgage investments and improve the distribution of investment capital available to very low-, low- and moderate-income households in the following markets:

  • manufactured housing
  • affordable housing preservation
  • rural areas

Now is the chance to make efficiency a key consideration in the underwriting process for these markets. The FHFA is seeking input through a 90-day public comment period on how the GSEs will be required to comply with this rule (the public comment period opened on December 15, 2015, with the press release and proposed rule here).

A coalition of organizations, led by the Institute for Market Transformation and Rocky Mountain Institute along with their respective networks, is coming together to prepare a coordinated public comment to present to the FHFA. The coalition will bring attention to the impacts energy costs have on these underserved markets, the quality of the housing stock they have access to purchase in the current lending paradigm, and the overall impact home energy performance has on default and collateral risk. To learn more about home energy upgrade financing, download Finance the Future, a new insight brief from RMI and the Institute for Market Transformation. We also invite you to join our efforts to influence this process by contacting us at

In reality most regulations are an interpretation of the law and perhaps new legislation is not what is required to reform financial institutions’ mortgage underwriting policies. The FHFA’s “Duty to Serve” public comment period offers an unprecedented opportunity to shape mortgage underwriting requirements in a way that both enhances Americans’ quality of life and supports an energy transformation all while improving the overall stability of our financial markets.