Is a PACE loan right for your home improvement project?

If you're looking to make energy-efficient home improvements, a PACE loan can be a compelling option. Learn more about the pros, cons, and alternatives to PACE financing.

Lee Huffman
August 23, 2023
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Making energy-efficient improvements to your home can improve its value and save money in the long run. However, these projects can cost a lot of money, and many homeowners don't have the funds. The PACE Loan program funds qualifying improvements to homes and are repaid through higher property taxes. Learn more about this unique financing option, how PACE loans work, and what PACE loan programs are available.

Understanding PACE loans

Property Assessed Clean Energy (PACE) loans enable property owners to make eligible home improvements without traditional financing. These loans are available for both residential and commercial properties.

They are an excellent option for homeowners who don’t have savings to make repairs or improvements. Rather than paying cash upfront, refinancing their mortgage or getting a home equity loan, homeowners agree to pay higher property taxes until the PACE loan is repaid. This allows the borrower to spread the cost of the project for up to 30 twenty years.

While these loans are unique, they still require repayment on an agreed-upon schedule. Like a traditional mortgage, PACE loans have origination fees and charge interest. If you stop making payments, the lender may foreclose on your home.

What PACE financing covers

PACE loans cover a variety of home improvements and repairs, but they do not cover every project a homeowner may want to do. Here are some examples of energy-efficient upgrades covered by PACE financing:

  • High-efficiency windows
  • Solar and/or tankless water heaters
  • Solar panels
  • Upgraded wall and roof insulation
  • “Smart” irrigation controllers
  • High-efficiency HVAC systems
  • Cool roof
  • Multiple improvements for deep energy savings

The savings from energy-efficient repairs and upgrades help to cover the loan payments. Additionally, the potential increase in home value and marketability of your house help to justify the cost.

Eligible projects may vary by state. Contact your lender or local government to obtain a complete list of what’s covered through PACE financing.

How PACE loans work

Getting a PACE loan for your home requires working with a participating lender and submitting an eligible project. Green banks and third-party lenders, such as HERO Program, CaliforniaFirst, Ygrene, and PACEfunding, typically provide funding for PACE loans. Local governments handle the money for these projects, including collecting payments from borrowers and remitting loan payments to the lender.

Repayment terms

PACE loans cover 100% of the cost of eligible projects. Repayment terms are up to 30 years. However, the actual repayment period usually aligns with the project’s useful life.

Instead of monthly payments like a traditional loan, you’ll pay higher property taxes each year until the balance is paid off. Many homeowners pay property taxes through escrow or impound accounts with their mortgage company. Your monthly PITI (principal, interest, taxes and insurance) mortgage payment could increase to account for this additional debt. If you make all of your payments on time, the loan will be paid off at the end of the term. When payments are missed or if you stop making payments, your home is at risk of foreclosure by the lender.

Tax treatment

Although PACE loans are repaid through higher property taxes, they fall under different tax rules. The payments are not deductible as property taxes. Instead, they act like mortgage interest on your tax returns.

Tax law allows for the deduction of mortgage interest when buying or improving your home. With PACE loans, you can only deduct the interest charges and not the repayment of the debt. The interest charges are in addition to interest paid through your primary mortgage.

Eligibility criteria

Getting a PACE loan means qualifying for its lending criteria. Every lender has different standards, but these underwriting standards are generally less stringent than a traditional mortgage:

  • Home equity. Lenders verify that you have enough equity in your home for your project by comparing your home's value against the total of your first mortgage and how much you want to borrow.
  • Mortgage payment history. Paying your mortgage on time shows the lender that you are able to keep your loan current.
  • Ability to repay. The lender verifies your income to ensure that you have the ability to make higher property tax payments to repay the loan.
  • FICO score. Your credit score is not as important to lenders with a PACE loan as it is with traditional lending.
  • Eligible improvements. Before the lender will fund your loan, they want to verify that your project is covered through this loan program.

Assumable loan

One of the main benefits and drawbacks of PACE loans are that they do not have to be repaid immediately upon the sale of your home. This allows the seller to transfer the remaining debt to the new homeowner, who continues to benefit from the energy-efficient improvements. However, this assumption of debt (through higher property taxes) can make it harder to sell your home in a competitive market. For example, a prospective buyer may discount their offer by the amount of the outstanding debt.

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Benefits of PACE loans

There are numerous benefits of using PACE loans to fund your energy-efficient repairs and upgrades. Here are a few reasons why you’d use this financing option:

  • No upfront costs. You do not have to pay any money out of pocket to obtain a PACE loan.
  • Lower interest rates. PACE loans offer lower interest rates than unsecured loans. The equity in your home secures these loans in case you stop making payments.
  • Assumable loan. When you sell your home, you do not have to pay off your PACE loan. The new homeowner assumes the debt and continues paying higher property taxes until the loan is repaid.
  • Potential increase in property value. Your home may increase in value by adding energy-efficient upgrades that reduce your utility bills.
  • Environmentally sustainable. Eligible projects are good for the environment by reducing your energy demand, carbon footprint and wasted energy.

Drawbacks and risks of PACE loans

PACE loans offer many advantages, but it is important to understand the drawbacks and risks of this type of financing before applying:

  • Higher property taxes. Until the loan is paid off, you’ll pay higher property taxes every year.
  • Potentially unaffordable payments. If the estimated lifespan of your repairs is shorter than average, your payments may be higher to pay off the loan quickly.
  • Refinancing challenges. PACE loans are in second position to your primary mortgage. If you want to refinance your mortgage, you may need to pay off your PACE loan or get approval from your PACE lender.
  • Harder to sell your home. Prospective buyers may balk at assuming the PACE loan. They may lower their bid for your home or demand that it be repaid out of the sale proceeds as a condition of their purchase.
  • Borrower understanding of PACE loans. Most homeowners know very little about the terms and conditions of PACE loans and lenders. This could lead them to pay higher fees and interest or agree to unfavorable loan terms.

Alternative ways to finance home improvements

PACE loans offer an innovative way to finance home improvements, but they aren’t the best choice for every homeowner. Before pursuing PACE financing, consider these other options first.

Personal loans

A personal loan is an unsecured loan that doesn’t require putting a lien on your home. These loans are much faster because they don’t need an appraisal. However, interest rates are generally higher because they don’t have an asset securing the loan.

FHA rehab loan

A 203(k) loan allows borrowers to finance up to $35,000 of their mortgage to cover repairs, rehab or improvements on their home. These loans can fund any type of project, even if they do not qualify as energy-efficient. An FHA rehab loan is a primary mortgage that you can use to purchase or refinance your house. If you have a low-rate mortgage, you may be hesitant to lose that rate through a 203(k) refinance.

Cash-out refinance

Refinancing your mortgage to pull out cash can be a good choice when current rates are at or below the rate of your existing loan. Closing costs can be expensive, and they can take up to 30 days or more for underwriting, appraisal and other parts of the loan process.

Home equity loan

A home equity loan or line of credit (HELOC) takes cash out of your home’s equity without replacing your primary mortgage. These loans also require an appraisal but are generally lower cost than a refinance. Home equity loans have a traditional amortizing loan payment, while HELOCs are usually interest-only for the first 10 years before requiring repayment of your balance.

Home Equity Investment (HEI)

With a Point HEI, you can finance home improvements with no monthly payments. Instead, you’ll share a portion of your home’s appreciation in exchange for tapping your equity.

Conclusion

A PACE loan is a unique way of financing energy-efficient home repairs and upgrades. This loan program charges origination fees and interest like a traditional loan, but it is repaid through increased property taxes. If you sell your home during the repayment period, the new owner assumes the higher property taxes until the loan is paid off. While this type of loan can help you fund repairs and upgrades without upfront payment, the higher property tax payments could make your home harder to sell. Consider all of your financing options before choosing a PACE loan.

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