In an effort to spur investment in renewable energy, water efficiency, seismic retrofits, and electric vehicle charging infrastructure, several bills have been passed into law in California in the last several years that expand the use and scope of the Mello Roos Community Facilities Act of 1982 and the Improvement Act of 1911. The changes to the laws that relate to clean energy improvements, commonly referred to as PACE assessments, can be used for property improvements such as insulation or solar panels, however, the laws can also be used for the financing of other categories of improvements not related to clean energy. The concern for lenders is two-fold. First under these programs property owners can enter into voluntary assessments, which result in a lien that has priority over present and future deeds of trust and second, the Freddie Fannie & Freddie Mac secondary market will not purchase loans with a Pace-Hero Lien on the property, which limits the financing to a buyer of property with that type of lien.
Let’s go back a little bit. What does PACE stand for? It is an acronym for
. Property Assessed Clean Energy Assessments. PACE programs provide financing to home and business owners for pursuing renewable energy systems and energy efficiency improvements. Pace programs have been gaining popularity across the U.S. Over 21 states, as well as the District of Columbia, have passed PACE enabling legislation. Local governments establish special tax districts with which property owners may apply for a property tax assessment in exchange for funds to implement renewable energy and energy efficiency improvements. The lien secures the assessment (which is in effect a loan) that in tum is paid-down annually or semiannually over a period of several years (usually 15 to 20 years) by the property owner via their property tax bill. The property assessments are not all that dissimilar from other types of property tax assessments, such as sewage and road improvements: the main difference being that the improvements occur on individual private prope1iies as opposed to public property or across several private properties (i.e., a community improvement).
The main California PACE program is called HERO, which stands for Home Energy Renovation Opportunity. The HERO Program touts a local government partnership offering affordable financing option for energy-efficient upgrades for increased efficiency, comfort and savings, including water-saving upgrades in drought impacted areas. Any property owner who lives in a city or county where HERO has been approved by the local government can apply for HERO financing. The financing is up to 20-year terms and a homeowner can borrow up to 15% of the home’s value. The financing is paid through the property taxes with a line item titled “HERO FINANCING” on the property tax bill. If property tax payments are through an impound escrow account, the lender will adjust the monthly payment to include the amount due for HERO financing. A list of HERO eligible products can be found on the HERO website at www.heroprogram.com/products. HERO products are installed by HERO Registered Contractors, with the vendor contract recorded against the property along with the assessment lien.
Specific HERO Financing eligibility requirements for residential properties include, but are not limited to, the following:
- Applicant(s) must be the owner(s) of record for the respective property.
- Mortgage-related debt on the Property must not exceed 90% of the value of the Property.
- Property owner(s) must be current on their property taxes and there must be no more than one late payment in the past three years.
- Property owners must be current on all Property debt of the subject Property at the time of application and cannot have had more than one 30 day mortgage late payment over the previous 12 months.
- Property owner(s) must not have had any active bankruptcy within the past two years, and the Property must not be an asset in an active bankruptcy. If a bankruptcy was discharged between two and seven years prior, and the property owner(s) has not had any additional late payments more than 60 days past due in the last 24 months, the property owner may be considered for approval.
- The Property must not have any federal or state income tax liens, judgment liens, mechanic’s liens, or similar involuntary liens
The issue with these programs is that the payments are collected through the property taxes. Thus a homeowner’s property tax bill can sky rocket, which can lead to foreclosure, and can create a priority lien over a first position lender. Meaning, if there is a delinquency, the PACE lien can jump ahead of other obligations (like a mo1igage or a mechanic’s lien) secured by the prope1iy. This jumping ahead in line means the PACE obligation is paid first, even if it was attached to the property long after the mortgage or other lien, and even if it was done without the consent of the senior lenders. This can negatively affect the buying or selling process in limiting financing options due to HUD and Freddie Mac & Fannie Mae limitations as well as cause confusion by sellers, buyers and lenders not understanding how these programs really work or the priority status of
Real Estate Agents will need to disclose the additional assessment on the property tax bill and although any remaining balance can transfer to a new buyer since the improvement is a fixed asset that stays with the property, the buyer’s lender may require the balance to be fully or partially paid off to help with the buyer’s debt-to-income ratio. The lender will have to agree to have the HERO balance transferred to the buyer. The lender will not lend if it cannot be insured in first position as the tax assessment may have super-lien status and/or take precedence over the first-lien mortgage in the event of a default. Thus a subordination of the HERO assessment will be needed in order for the balance to transfer. Even with the subordination agreement, many lenders will not lend unless the assessment is fully paid. Also some title insurance companies will not insure a property with a PACE-HERO lien which will cause closing issues as lenders won’t lend without title insurance.
Per an August 20, 2014 Selling Notice, the following is related to Fannie Mae’s guidelines to PACE lien loans:
“Several California counties have announced energy retrofit programs that permit the imposition of first-lien priority to secure energy efficient home improvements. This Notice is provided as a reminder of the Fannie Mae policy prohibiting first-lien Property Assessed Clean Energy (PACE) loans on properties securing single-family mortgage loans.
Certain energy retrofit lending programs, often referred to as PACE programs, are offered by localities to finance residential energy improvements with loans that are generally repaid through the homeowner’s real estate tax bill. These loans typically have automatic first-lien priority over previously recorded mortgage loans.
As set forth in the Selling Guide, B5-3.4-0l, Property Assessed Clean Energy Loans, Fannie Mae will not purchase mortgage loans secured by properties with an outstanding PACE or PACE-like loan unless the terms of the PACE loan program do not provide for lien priority over first mortgage liens. (Fannie Mae does make an exception for refinances with a PACE loan originated prior to July 2010.) Lenders must monitor state and local law to determine which jurisdictions offer PACE loans that may provide for lien priority. Moreover, the terms of the Fannie Mae/Freddie Mac Uniform Security Instruments prohibit loans that have senior lien status to a mortgage. If the PACE loan is structured as a subordinate lien or unsecured loan, the first mortgage loan may be underwritten to Fannie Mae’s standard guidelines.
To the extent necessary to mitigate greater risks associated with PACE programs, Fannie Mae may take additional actions that may include pricing /or risk, limiting loan-to-value ratios or adjusting debt-to-income ratios for loans secured by properties located in jurisdictions that permit such first-lien PACE programs.”
Per a recent Mortgagee Letter dated July 19, 2016, the following is related to HUD/FHA’s guidelines to PACE Lien Loans:
FHA supports the goals of clean energy, energy efficiency, and resilience. Property Assessed Clean Energy (PACE) programs may provide an alternative means of financing energy and other PACE-allowed improvements to residential properties using financing provided by private ente1prises in conjunction with state and local governments.
The terms and conditions of the PACE obligation may vary by state, local government, and PACE program. PACE programs also determine the scope of allowable improvements made under their respective PACE programs.
Generally, the repayment of the PACE obligation is collected in the same manner as a special assessment is collected by the local government, rather than paid directly by the Borrower to the party providing the PACE financing. Generally, the PACE obligation is also secured in the same manner as a special assessment against the property. In the event of the sale, including a foreclosure sale, of the property with outstanding PACE financing, the obligation will continue with the property causing the new homeowner to be responsible for the payments on the outstanding PACE amount. In cases of foreclosure, priority collection of delinquent payments for the PACE assessment may be waived or relinquished.
The Department of Energy is updating its Best Practices Guide lines for Residential PACE financing, which may be used by states and counties to align with their consumer protection goals.
FHA regulations at 24 CFR §203.32(a) require, in part; that with certain exceptions, at the time the mortgage is offered /or insurance, the property must befiee and clear of any liens other than the FHA-insured mortgage. In
Addition, FHA regulations at 24 CFR §203.41 (c)(2) require that any restrictions on conveyance automatically terminate if title to the mortgaged property is transferred by foreclosure or deed-in-lieu of foreclosure, or if the
FHA-insured mortgage is assigned to the Secretary.
Outstanding PACE Obligations
Properties which will remain encumbered with a PACE obligation may be eligible for FHA-insured mortgage financing, provided that the mortgagee determines that the following requirements have been met:
- Under the laws of the state where the property is located, the PACE obligation is collected and secured by the creditor in the same manner as a special assessment against the property;
- The property may only become subject to an enforceable claim (i.e., a lien) that is superior to the FHA-insured mortgage for delinquent regularly scheduled PACE special assessment payments. The property shall not be subject to an enforceable claim (i.e., lien) superior to the FHA-insured mortgage for the full outstanding PACE obligation at any time (i.e., through acceleration of the full obligation.)However, a notice of lien for the full PACE obligation may be recorded in the land records;
- There are no terms or conditions that limit the transfer of the property to a new homeowner. Legal restrictions on conveyance arising on a PACE obligation that could require the consent of a third party before the owner can convey the real property are prohibited, unless such provisions may be terminated at the option of, and with no cost to, the homeowner;
- The existence of a PACE obligation on a property is readily apparent to mortgagees, appraisers, borrowers and other parties to an FHA insured mortgage transaction in the public records and must show the obligation amount; the expiration date and cause of the expiration of the assessment, and in no case may default accelerate the expiration date; and
- In the event of the sale, including a foreclosure sale, of the property with outstanding PACE financing, the obligation will continue with the property causing the new homeowner to be responsible for the payments on the outstanding PACE amount.
Disclosure of PACE Obligation, Terms and Conditions upon Sale
For properties with existing PACE obligations, the property sales contract must indicate whether the obligation will remain with the property or be satisfied by the seller at; or prior to closing. Where the obligation will remain, all terms and conditions of the PACE obligation must be fully disclosed to the borrower and made part of the sales contract between the seller and the borrower.
Where energy and other PACE-allowed improvements have been made to
the property through a PACE program, and the PACE obligation will remain outstanding, the appraiser must analyze and report the impact on the value of the property, whether positive or negative, of the PACE -related improvements and any additional obligation (i.e., the PACE special assessment). ”
You may be thinking wow, so here is some good news. The California Legislature is currently taking up Assembly Bill AB 2693. AB 2693 will make two important consumer protection changes to PACE loan agreements.. First, the PACE loans will be accompanied by the same truth in lending disclosures as any other loan. Second, the PACE encumbrances will receive the same priority status as any other loan.
If passed, this would help clarify all of the above described and be a tremendous help for lenders, sellers, buyers, realtors and title insurance companies