Will defaulting on a home improvement loan make you lose your house? You might not think so, but the PACE loan program has ushered in a new era of predatory lending. The Sarasota County commission will vote on a PACE ordinance this Wednesday, which, if approved, can create huge risks for Sarasota homeowners. Hyped as a “green” lending program focused on financing clean & efficient energy home improvements, PACE (Property Assessed Clean Energy) loans put a lien on a property that takes payment priority over any existing mortgage. Default on a PACE loan, and you could indeed lose your house.
PACE loans are predatory because the risks of lending are transferred from the PACE lender to the mortgage lender, creating a risk of seizure or foreclosure which is unprecedented for a home improvement loan.
A homeowner who borrows through the PACE program will pay an annual PACE loan payment as an assessment via their property taxes, which is collected by their County government. For many borrowers, the PACE program masquerades as a government lending program, leading to confusion as to the true terms of the loan.
If a borrower falls on hard times, or borrows failing to understand the terms, that homeowner may find they are unable to pay their property tax assessment in full (for example, in California one PACE borrower’s property tax assessment increased from $310 annually to over $5,476). Once in default, the PACE lender may then move to seize the property and force a sale, and will collect the full amount of the PACE loan before the mortgage lender is made whole. Alternatively, the mortgage holder may pay the PACE assessment and move to foreclose. Even if a borrower is fully qualified (many PACE loans have been fraudulently sold to unqualified borrowers), if a homeowner’s financial circumstances change, an unpaid PACE loan can have devastating consequences (seizure or foreclosure) which would not occur with a home equity or home improvement loan.
PACE loans may also charge predatory interest rates. These days home equity loans typically charge 3-5% interest. Government loan and grant programs exist to assist low income homeowners with energy efficient improvements at even better rates (the grants are free). PACE loans charge 7-9% But if you look closely at a PACE loan, the real rate may be even higher due to closing fees.
A PACE lender includes a loan calculator on their website. For a $250,000 home, that lender estimates you will borrow $50,000. They claim an annual interest rate of 6.5%, with an APR of 7.4%. The APR calculation exists to standardize interest rate calculations as part of the Truth in Lending law. Leave it up to the banks, and they will find all kinds of ways to calculate interest in a way which hides the real costs of borrowing to you.
If you take a closer look at the same PACE lender, and include all your closing costs as the cost of borrowing (interest) and count only the money you actually get to use for your home improvement project as principal, the APR I calculated turns out to be 11.5% – and that is a low number because the calculation does not account for the fact that the closing costs are paid up front – not over the 20 years of the PACE loan term. Up front costs increase the cost of borrowing, or interest. If you want to understand the numbers, read on, if not skip to the last bolded section.
Here are the numbers
This standard measure of the cost of borrowing is known as the annual percentage rate (APR), and its formula for calculation is:
i = 2 x n x I / P(N + 1)
i is the APR
n is the number of payment periods in one year
I is the total financing charges (mostly interest)
P is the principal (the amount borrowed), and
N is the number of scheduled payments
Read more: http://web.finweb.com/loans/calculating-interest-rates-and-apr.html#ixzz4v2HxBrjW
For a $250,000 house, the suggested loan amount is $50,000. The PACE lender charges a $2000 cost of issuance, $2627 capitalized interest and $695 processing fee. These are all costs of borrowing – or interest – and leave $44,678 left for the project. The true amount of the loan – the actual amount of money that the borrower gets to use over the 20 year life of the loan – is $44,678.
The estimated annual payment is $4,674, and the number of payments is 20.
To calculate the total amount of interest paid, multiply the annual payment by 20 (the number of payments), add the other costs of borrowing (cost of issuance, capitalized interest, processing fee – the upfront costs) and subtract the true loan amount ($44,678).
[(4674 x 20) + 5322] – 44,678 =
(93,480 + 5322) – 44,678 =
98,802 – 44,678 = 54,124
$54,124 is the total amount of interest paid ($98,802 is the total amount of principal and interest payments over 20 years)
Let’s plug the numbers into the APR equation
i = 2 x n x I / P(N + 1)
i = 2 x 1 x 54,124 / 44,678 (20+1)
i = 108,248 / 938,238
i = 11.5%
If you consider that a chunk of money is being paid up front, and this equation is only equipped to spread the costs out over 20 years, that result of 11.5% is actually below what the true interest rate, or annual cost of borrowing is.
Some PACE advocates who haven’t taken a close look at how these loans are structured may say home equity and home improvement loans have closing costs too. That’s true – some do. But in a day and age when you are getting 1/2% a year for your savings account, when interest rates are so low, there are lenders who are lopping off closing costs to get your loan business.
Bottom line: PACE loan rates are high, some (the majority?) are predatory
Finally, PACE loans are predatory because they are being bundled and sold as Wall Street securities. This creates a market dynamic which results in aggressive sales tactics with a propensity to ignore whether or not a borrower can actually pay off the loan.
Once again, PACE loans are originated by private lenders and are secured by a lien via the property tax bill. That lien takes priority over any existing mortgage. The risk of lending is removed from the private lender. The private lender (for example, Renovate America) then bundles those loans and sells them as securities. The yield on these securities is 3-4% (notice the spread! If the true “take” is over 10%, and the banks are paying out only 3-4% on the securities, they are pocketing a nice chunk of change).
The sale of securities explains why mortgage lenders aren’t crying foul. If they are selling PACE securities down the hall in their organization, then they are willing to overlook the risk. The one who gets the shaft if they fail to keep up with the loan, or just pay a grossly inflated interest rate, is the homeowner.
Wall Street’s appetite for these securities, along with the failure of the loan originator to have any actual risk of lending – these dynamics combine to create a business environment which encourages predatory lending, just like the mortgage lending crisis of 2008.
The FBI and SEC are looking into PACE lending practices
Solar panels, energy efficient appliances, hurricane hardened windows – these and other clean, efficient energy improvements are a good thing. But they must not distract from the realities of PACE financing. Using energy efficiency as a tactic to distract from a predatory financial reality is today’s greenwashing of predatory lending.
Tell the Sarasota County Commission to vote NO on the PACE loan ordinance this Wednesday, October 11th
email them at email@example.com
attend the 9 am meeting, number 7 on the agenda
1660 Ringling Blvd