Home Energy Ratings: A Primer

What are Energy Mortgages?

A generic definition of an energy mortgage is a mortgage that credits a home's energy efficiency in the home loan. For an energy efficient home, for example, it could mean allowing the borrower a greater debt-to-income ratio and giving the home buyer the ability to buy a higher quality home because of the lower monthly costs of heating and cooling the home. For homes in which the energy efficiency can be improved, this concept allows the money saved in monthly utility bills to finance energy improvements.

A variety of energy mortgages have appeared in recent years and more are anticipated as the Residential Energy Services Network (RESNET), the operating home energy rating systems and the Environmental Protection Agency increase education/information outreach. Energy mortgages come in two basic categories: energy efficient mortgages used to finance homes that are already energy efficient, and energy improvement mortgages used to improve the efficiency of existing homes. Energy mortgages are sponsored by both federally insured mortgages programs (Federal Housing Administration and Veterans Administration), as well as, the conventional secondary mortgage market (Fannie Mae and Freddie Mac).

As interest in improving the energy efficiency of America's housing stock increases, so has the availability of energy mortgages. A variety of approaches have been piloted in select states and several energy mortgage programs are now available nationwide. The two types of energy mortgages are:

ENERGY EFFICIENT MORTGAGES (EEMs) - In its initial form, the energy efficient mortgage was a straight two percent stretch which allowed the buyers of energy efficient homes to qualify for up to two percent more debt because of their lowered monthly utility costs. This stretch allowed more buyers to afford the higher quality, energy efficient homes. This program has worked best when a home energy rating system is available to document the relative efficiency of a home.

One state housing finance agency experimented with an interest rate reduction program which allowed the buyers of homes with home energy ratings exceeding the state's energy code to qualify for lower interest rates. Another state housing finance agency has offered down-payment assistance for the purchase of high energy-rated homes. Both programs were extremely successful in spurring consumer demand for energy efficient homes.

The U.S. Department of Housing and Urban Development's Federal Housing Administration (FHA) recently announced its version of the energy efficient mortgage program. Basically, FHA will allow home buyers to finance the energy efficiency of a new home above its appraised value when the home energy rating documents the home exceeds the Model Energy Code. Through this program, home buyers can purchase homes whose prices exceed FHA limits.

UPGRADES OF EXISTING HOMES - This type of energy efficient mortgage finances cost-effective improvements recommended in an energy rating through the mortgage at the time of sale or refinancing. A home energy rater inspects the home and makes recommendations on cost-effective energy improvements. The rating also provides information on the relative economic return on the improvements. The funds for the improvements are placed into an escrow by the lending institution. The home owner has a minimum of three months after closing to make the improvements. Once the improvements are made, a post-improvement home energy rating is performed to confirm the improvements were installed. The lending institution then releases the escrow funds to pay for materials and contracted labor. The total expended is rolled into the mortgage loan. The FHA and VA mortgage energy improvement mortgage programs can finance energy improvements above the appraised value, if the measures are shown to be economical.