Energy Efficient Homes Make Lower Risk Mortgages

Many have theorized that energy-efficient homes should have lower default risks than standard homes because the former are associated with lower energy costs, which leaves more money to make the mortgage payment.

However, few empirical studies have been conducted due to limited data availability. The University of North Carolina did a study in 2013 and other studies have supported this data. Mortgage Companies are starting to look at these facts.

Home Energy Efficiency and Mortgage Risks

A report published by the UNC Center for Community Capital and the Institute for Market Transformation- March 2013

Key Findings

  • Loans on ENERGY STAR homes are 32 percent less likely to go into default.
  • Within efficient homes, the more efficient the house, the lower the default risk. For each point on the Home Energy Rating System (HERS) index of efficiency, the risk of default drops.
  • This is the first report of its kind and is based on a sample of 71,000 home loans from across the country. The level of confidence is 99 percent.
  • The findings have significant policy implications: Lenders might allow for lower risk premiums that are associated with interest rates, a more flexible credit profile, or a higher debt-to- income ratio for people buying or refinancing efficient homes. This would increase the affordability of energy-efficient homes among many borrowers, especially in high-cost areas.
  • Lenders may want to require or strongly recommend an energy audit or energy rating during the process of mortgage underwriting. In the same manner that appraisals are done to calculate the value of the home, an energy rating or audit could define other important loan characteristics.
  • The study controls for: the size of the house; the age of the house; neighborhood income;* house value relative to the area median value; local unemployment rate; borrower credit score; loan-to- value ratio;* loan type; local weather; price of electricity. *Proxies for borrower income
  • The sample is restricted to single-family, owner-occupied houses whose loans originated from 2002 to 2012 and were used for purchase only. About 35 percent of the homes in the sample are energy efficient, i.e., ENERGY STAR rated.

Frequently Asked Questions

Are the homes in this study higher-end than the norm? Is that why they’re less likely to go into default?
The average sale price of the homes in the sample was about $220,000 (for both the energy-efficient and less-efficient homes. These are not just luxury homes.
Do the findings have more to do with the type of borrower than the efficiency of the home?
The study controlled for neighborhood income and loan-to- value ratio, which are proxies for borrower income. But the possibility of some degree of self-selection can’t be ruled out. Buyers of energy-efficient homes may be more financially astute than other borrowers. The authors identify this as a question for future research. However, if the purchase of an efficient home does signal a savvier borrower, this is an important factor for lenders to consider, as these borrowers present a lower risk.
Are these new homes only? What about condos?
They are both new and older homes. The sample was restricted to owner-occupied, single-family homes whose loans originated during 2002-2012. Condominiums were not included.
Since ENERGY STAR homes are newer, on average, did this affect the results?
To account for the distributional differences in age between the ENERGY STAR and non-ENERGY STAR homes, we ran a model restricting the sample to houses that were built after 2000.
Why was the debt-to- income ratio excluded?
As a rule, ability to pay (captured by debt-to-income ratio or DTI) has been omitted from most loan termination studies due to methodological considerations. Controlling for income, DTI is generally found to be insignificantly associated with default.

20 Years of ENERGY STAR
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