The U.S. Department of Housing and Urban Development (HUD) and Federal Housing Administration (FHA) issued Mortgagee Letter 2016-11, which specifically permits properties encumbered with a Property Assessed Clean Energy (PACE) obligation to be eligible for FHA-insured mortgage financing, whether for new purchases or refinancing. The guidance goes into effect this week on September 17, 2016. Here is what you need to know about the changes.
PACE Obligations May Be Superior or Subordinate, But May Not Fully Accelerate
The FHA guidance stresses that PACE obligations must be treated and follow the same rules as other special tax assessments levied by municipalities. In that vein, FHA will require that only delinquent payments may take priority over a mortgage. A delinquency on a PACE obligation cannot trigger acceleration of the entire loan. In the event of a sale, including a foreclosure, the PACE obligation will run with the land, and the new homeowner will be responsible for payments on any outstanding PACE amounts. In the event of a foreclosure, municipalities or other PACE administrators may allow any priority on the delinquent payments to be subordinated, waived, or otherwise relinquished. The PACE industry has embraced this guidance and begun to use it in its pitches to lenders as a way to quell fears that PACE loans are a risk to the safety and soundness of mortgage loans.
The PACE Loan Must Meet Certain Criteria to Be Eligible
In order for a PACE-encumbered property to be considered for FHA-insured mortgage financing, the mortgagee must verify that the following requirements are met:
- Must be a special assessment – The PACE obligation must be treated like a special tax assessment under the PACE-enabling legislation or ordinance. Accordingly, PACE obligation payments should be made to the local municipality in the same way that the property owner makes its local property payments. For collection purposes, the PACE program should not deviate in how they collect PACE obligation payments from the way in which they collect other tax assessments.
- No Nevada HOA-type problems – Under the PACE-enabling legislation or ordinance, only delinquent special assessment payments may take priority over a mortgage. While the entire PACE obligation may be recorded in local property records, the entire PACE obligation cannot be accelerated upon delinquency.
- PACE obligation must freely and automatically transfer upon sale – The PACE-enabling legislation or ordinance may not limit the transfer of the property to a new property owner.
- PACE obligations must be recorded on the land records – PACE obligations must be recorded in the public records and include: (1) the expiration date and (2) the cause of the expiration (which cannot be caused by acceleration by default).
- Outstanding PACE obligation must run with the land– In the event of a sale, including a foreclosure sale, any outstanding PACE obligation must continue with the property, causing the new homeowner to be responsible for making the payments on the outstanding PACE amount.
New Disclosure and Appraisal Requirements
Under the FHA guidance, when a PACE-encumbered property is sold, the property sales contract must indicate whether the seller will satisfy the PACE obligation at or before closing or whether the obligation will remain with the property. If the obligation will remain with the property, the property sales contract must include and incorporate all terms and conditions of the PACE obligation. Additionally, if the obligation will remain with the property, the appraiser must analyze and report the impact of the PACE-related improvements on the value of the property.
Guidance May Expand Residential PACE Obligations, So Mortgagees Should Develop Policies to Address PACE in Origination and Servicing…
It is anticipated that FHA’s guidance will lead a number of municipalities to pass new PACE-enabling legislation. We also expect to see municipalities that currently have PACE programs in the commercial space expand to allow residential property owners to obtain PACE loans. Lenders should be aware that they are more likely to see PACE obligations appear when conducting underwriting, and they should have policies and procedures in place to ensure that the PACE obligation conforms to FHA guidance. Servicers should be aware that PACE obligation may be superior to the mortgage and understand the mortgagee’s rights in the event a borrower defaults on a PACE obligation. Servicers may also need to consider PACE obligations on foreclosure properties in REO.
… But FNMA and FHLMC May Not Purchase Mortgages on PACE-Encumbered Properties
Despite a change of heart on PACE loans by the FHA and the Veterans Administration, the Federal Housing Finance Agency’s (FHFA) has made no indication that it will change its position prohibiting Fannie Mae, Freddie Mac, and Federal Home Loan Banks from purchasing mortgages on PACE-encumbered properties. Lenders and servicers that work with the FHA and the FHFA will need to ensure that its policies are consistent with both agencies’ directives.