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This Clean Energy Home Loan Program Has Problems. California's Trying to Fix Them.

The state has passed unprecedented regulations to protect borrowers from taking on debt they can't afford to pay back.

A contractor adds weather insulation to the windows of a house.
A decade after California became ground zero for what is now one of the country’s fastest-growing home loan programs, the state has passed unprecedented regulations to protect borrowers from deceptive financial practices.

The program, property assessed clean energy (PACE) financing, offers loans to help residential or commercial property owners pay for energy-efficient upgrades, such as solar panels, LED lighting and window insulation. The residential loans are typically around $25,000, and the terms are for up to 20 years. They are automatically paid back through the borrower’s property tax bill, making local governments responsible for collecting the payments.

The idea is that the energy savings generated from an upgrade would help property owners pay back the loan. Local governments that have launched PACE programs say they create jobs, help homeowners save money on their electricity bills and reduce their community's energy footprint.

But in California, which accounts for most of the program's growth and is home to the nation's first PACE program in Berkeley, the government-supported financing model has increasingly come under fire from those who are concerned that homeowners are taking out loans they can’t afford on the advice of contractors eager to profit from the installation work.

“There hasn’t been a lot of these things, but it’s been enough that it’s worrying,” says Tim Fisher, coordinator of legislative and federal affairs for ‎the Council of Development Finance Agencies. “People can get taken advantage of or get caught up in signing up for something they don’t really want.”

In Los Angeles, for example, Cassina Edwards told the Los Angeles Times that her mother, who receives $11,600 a year from Social Security and suffers from dementia, took out a roughly $50,000 PACE loan. Edwards said the contractor explained that “a government program” would help her mother afford the improvements but never explained how that would work or that she could lose her house if she missed payments. Her mother defaulted on her first payment of $5,500.

In response to stories like these, the California Legislature this year approved a slew of new requirements in two separate bills designed to protect homeowners. The protections -- which were signed into law in October -- include a first-in-the-nation requirement that property owners' ability to pay is considered, and they allow for a three-day grace period in which the homeowner can cancel their PACE loan contract with no penalty. 

The new laws also create standards for contractors, who typically are the first point of contact for homeowners taking out a PACE loan. Under the law, contractors selling PACE loans in California have to meet minimum training requirements and are barred from receiving kickbacks from PACE financing companies. Lenders, meanwhile, are barred from offering incentives to property owners who take out a PACE loan.

The industry has been generally supportive of California’s new regulations. Because PACE programs are administered locally, they can vary widely between jurisdictions. “Without cohesive guidance at the state level, it’s harder to ensure everybody plays by the rules,” says Cisco DeVries, CEO of PACE lender Renew Financial and the pioneer behind Berkeley’s PACE program.

The legislation also includes new data reporting requirements and could shed more light on what -- if any -- role PACE loans might be having on default rates in California.

The picture has so far been incomplete. According to an August Wall Street Journal analysis of tax data in 40 California counties, defaults have jumped over the past year. Roughly 1,100 borrowers missed two consecutive payments in the tax year that ended June 30, compared with 245 over the previous year. PACE lenders counter that the role of energy efficiency loans is negligible because the default rate cited by WSJ -- less than 2 percent -- is in line with historic default rates on tax bills.

The PACE industry has another reason for supporting state action, though: Proposals at the federal level are far less favorable.

Nationwide, PACE residential loans have skyrocketed from $200 million at the end of 2013 to $4.4 billion today, according to the industry group PACE Nation. But despite its growth, the industry is vulnerable: Twenty-two states have passed PACE-enabling legislation for residential properties, yet programs only exist in California, Florida and Missouri. Federal legislation could spell disaster.

U.S. Republican Sen. Tom Cotton or Arkansas has called PACE financing “a scam” and said that “lenders are changing state and local laws to trick seniors into taking out high-interest rate loans for 20 years, along with liens on their homes, for technology that could be obsolete in a few years.” He has introduced a bill that would require PACE lenders to follow the same regulations and disclosures as banks and mortgage lenders.

Lenders say such regulations would effectively kill the industry because it would increase the cost of lending and require local governments administering the loan payments to essentially act as mortgage lenders.

Making matters potentially worse for the industry, the Federal Housing Administration this month, in response to criticism that homes with PACE liens have become too difficult to sell, announced it will stop insuring new mortgages on homes with PACE loans.

DeVries says he hopes that California’s model will show federal officials that local control can help PACE programs work and protect consumers.

“Local officials can choose the terms and conditions under which it is available,” he says. “That’s a powerful thing: If it’s not working, people have the ability to talk to their local elected about it. That’s unlike any other financial product.”

Liz Farmer, a former Governing staff writer covering fiscal policy, helps lead the Pew Charitable Trusts’ state fiscal health project’s Fiscal 50 online resource.
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