A Guide to Energy-Efficient Mortgages
When you get that first electric bill of the summer, it’s easy to start thinking about how to make your home more energy-efficient.
More than a third of homebuyers are willing to pay at least $10,000 upfront in order to save $1,000 annually on their utility bills, according to a new study from the National Association of Home Builders. Another 46% of buyers would pay between $1,000 and $9,999 now to save money later.
With that in mind, many lenders have introduced “energy-efficient” mortgages, specialized to help homeowners purchase a new “green” home or make improvements to an existing property.
This guide explains how these types of mortgages work, how to qualify for one and their benefits and drawbacks. We’ll cover:
- What is an energy-efficient mortgage?
- Types of green mortgages
- How to shop for a green mortgage
- Green mortgage pros and cons
What is an energy-efficient mortgage?
An energy-efficient mortgage (EEM) is a type of home loan that allows a homebuyer to finance the cost of an energy-efficient house or cover what it would cost to make energy improvements to a house. Often called a “green mortgage” for short, these loans typically offer buyers a better mortgage rate or a larger loan amount to help them achieve energy efficiency in their new home, according to the U.S. Department of Energy.
EEMs can be used to buy a home that is already energy-efficient, such as an Energy Star-certified home. In those cases, the homebuyer would need a home energy rater to assess the property’s energy rating before a lender will approve the loan. In these cases, borrowers qualify for larger mortgages than they would otherwise.
An energy-efficient mortgage can also be used to make an existing home more environmentally friendly. This type of loan may also be referred to as an energy-improvement mortgage. In these cases, a lender might require a home energy rating to verify the potential amount of monthly energy savings and the value of the energy efficiency measures being implemented.
How they differ from regular mortgages
An energy-efficient mortgage is actually similar to a standard home loan, except that there are factors related to energy savings that must be accounted for in the underwriting and approval process.
“Other than the fact that it’s a consideration for your mortgage, it’s not a separate mortgage,” said Pava Leyrer, chief operating officer at Northern Mortgage Services in Grandville, Mich.
Put another way, an energy-efficient mortgage doesn’t stand alone — you’re simply increasing the loan amount of your regular mortgage to pay for either an existing eco-friendly home or one that needs energy improvements.
Types of green mortgages
There are three types of energy-efficient mortgages: conventional, FHA and VA. Below, we explain each type and their qualification guidelines.
Government-sponsored enterprises Fannie Mae and Freddie Mac have conventional loan products that cater to homebuyers looking for energy efficiency in their new home. In addition to meeting the requirements for a standard conventional loan, both Fannie and Freddie have outlined specific green mortgage guidelines.
Generally speaking, you must meet the following criteria to qualify for a conventional loan:
- Have a minimum 620 credit score.
- Contribute at least a 3% down payment. (Increase that amount to 20% to avoid paying private mortgage insurance.)
- Provide proof of stable employment and income.
- Have a debt-to-income ratio of 43% or less. A slightly higher DTI ratio is possible if you have compensating factors, such as a credit score above 700.
Essentially, the Fannie and Freddie programs allow buyers to borrow more money to invest in making their new home more energy-efficient.
Fannie Mae’s HomeStyle® Energy Mortgage is available through approved lenders for borrowers who would either like to purchase a home or refinance their mortgage. The loan can be used for several purposes, including:
- Energy and water system upgrades
- Installing energy-efficient windows and doors
In cases where a borrower is weatherizing their home, by air sealing or adding insulation for example, Fannie Mae provides a $3,500 allowance for financing those projects, and there is no energy report required.
The features of a HomeStyle® Energy loan can be combined with other Fannie products, such as the HomeReady® mortgage. Combining a HomeReady® mortgage with the HomeStyle® Energy loan would be ideal for a homebuyer who is looking for a conventional mortgage product with a low down payment requirement and also wants to make energy improvements.
Freddie Mac’s GreenCHOICE Mortgage allows borrowers to finance the purchase of an energy-efficient home or improvements to an existing home, and also permits no cash-out refinances.
The maximum financing amount is equal to 15% of what the home’s value would be after the energy improvements are made. GreenCHOICE allows financing for basic energy and water efficiency improvements, including:
- Programmable thermostats
- Caulking or weather stripping
- HVAC replacement
- Solar water heaters
All energy-efficiency improvements must be completed within six months after the mortgage closes.
The Federal Housing Administration’s energy-efficient mortgage product allows buyers to purchase the home plus cover expenses to improve the home’s energy efficiency. Improvements may include active and passive solar or wind technologies, and other energy-saving equipment.
The maximum financing amount for energy improvements is 5% of the lesser of these three options:
- The home’s value
- 115% of the median area price of a single-family home
- 150% of the national conforming loan limit
Additionally, the FHA allows borrowers to qualify with a slightly higher debt-to-income ratio to finance the purchase of an existing energy-efficient home. There’s also a $3,500 allowance for basic weatherization items, and the option to combine an FHA EEM with another FHA loan, such as the 203(k) rehabilitation mortgage.
Keep in mind, you must also meet standard FHA loan requirements, which include a 580 credit score, 3.5% down payment and steady income and employment.
Energy-efficient mortgages through the Department of Veterans Affairs are exclusive to active-duty military members, reservists, veterans and their families. The energy-efficiency feature is combined with a standard VA loan to make improvements to an existing home either by purchasing or refinancing. Generally speaking, the VA will finance up to $6,000 in energy improvements, but the utility cost savings must offset the larger monthly mortgage payment. Lenders may finance more costly improvements, but borrowers must have sufficient income to cover the increased monthly payments.
Energy improvements might include:
- Additional insulation
- Caulking and weather stripping
- Solar heating and cooling systems
- Storm windows and doors
Standard VA loan eligibility requirements include a VA loan certificate of eligibility, proof of steady income and a funding fee charged at closing. While there are no published minimum credit score and maximum debt-to-income ratio, most VA lenders expect at least a 620 credit score and maximum 41% DTI.
How to shop for a green mortgage
In many ways, you shop for an energy-efficient mortgage the same way you’d shop for a standard mortgage. First, have a clear understanding of how much house you can afford. Aside from using a home affordability calculator, you’d want to get a mortgage preapproval for a solid idea of your housing budget.
Then you’ll need to gather mortgage quotes from multiple mortgage lenders and compare apples to apples. Pay attention to mortgage interest rates, annual percentage rates, discount points and other origination fees.
If you’re planning to make energy improvements to an existing home rather than buying a home that is already energy-efficient, you’ll need to know approximately how much those improvements will cost and whether they qualify as energy-efficient improvements based on the loan type — conventional, FHA or VA — and your mortgage lender’s guidelines.
Leyrer uses the example of a homebuyer wanting to finance the cost of an energy-saving furnace.
“There are lots of different (furnaces) you can buy, so if you’re not buying one that meets the requirements to be deemed energy-efficient, then you can’t use the parameters of that loan,” she said.
Be sure to check with your lender for clarity on which appliances and projects qualify to be financed through an energy-efficient loan.
Additionally, be sure you have a clear understanding of how long it would take you to recoup the extra energy improvement costs being added to your loan amount. Let’s use a quick scenario:
You find out your weatherization and energy-efficient appliance expenses add up to $5,000 and you want to finance them as part of your mortgage. These improvements are expected to save you $100 each month on your utility bill. In order to recover the $5,000 added to your loan, it will take between four to five years.
Green mortgage pros and cons
Energy-efficient mortgages have multiple benefits, but they aren’t without drawbacks. Consider the following pros and cons if you’re interested in this loan type.
- You potentially save several hundred dollars (or more) each year on utility expenses.
- You’re able to add the cost of your energy improvements to your mortgage.
- Your required down payment amount may not change.
- You might qualify for tax credits for certain fuel cell, geothermal, solar or wind energy improvements made to your home.
- The mortgage approval process may take longer.
- You’re taking out a larger mortgage, so your monthly payment will be higher.
- There are limits as to how much you can borrow for energy efficiency.
- There are limits to what appliances and projects are considered energy-efficient.
Another issue to be wary of is property liens, such as those imposed by the Property Assessed Clean Energy (PACE) program. The residential PACE program provides financing to homeowners who want to make energy improvements to their property and allows them to repay the loan over time as an assessment added to their annual property tax bill. This type of loan adds a lien to your property and gives it a priority position over your mortgage, which could prevent you from refinancing or selling your home in the future.
If you’ve previously borrowed a PACE loan, a conventional lender may allow you to repay it when taking out an energy-efficiency mortgage as part of a refinance transaction.
The bottom line
Going the extra mile to incorporate energy-efficiency into the home you’re purchasing can be time-consuming and pricey, so it helps to have a plan in place before you get too deep into the homebuying process.
“Do your homework upfront so that it reduces your stress,” Leyrer said.
The information in this article is accurate as of the date of publishing.