Philip Henderson, Senior Financial Policy Specialist, Washington, DC
When major insurers offer discounts for lower risk customers, it’s likely based on reliable evidence across a large population. Think lower car insurance rates for drivers with no speeding tickets. Discounts on life insurance for non-smokers.
Genworth, the large private mortgage insurance firm spun-off from General Electric, now offers a discount for homeowners buying more energy efficient houses (OK — Genworth implemented this policy in Canada — but reports suggest it’s coming to the US…)
Obviously, Genworth believes the risk of loss to the mortgage lender is lower when the borrower is in a more energy efficient house.
This policy makes a ton of sense and it reflects how energy efficiency operates on two related fronts.
First, consider the measures that make a home more energy efficient — better air sealing, more insulation, high performance appliances — these are attributes of a well-built house. These measures make a house more valuable. If the borrower gets into income trouble and can’t afford the house payments, the high-efficiency house will hold its value better — it can likely be sold for more than if it had been built to lower standards.
True, there is more work to be done with appraisals to account for the value of efficiency attributes, but that is happening.
Substantial evidence confirms that home value is a powerful driver of default losses for lenders — loans with lower LTV will result in lower losses for the lender. For more on that, see this paper by economist John Campbell. And this is where mortgage insurance works — it insures the lender against certain loan losses.
The second front is also important. Lower energy expenses mean the borrower might not get into income trouble in the first place. For any occupant, energy expenses will be lower in a well-built house as compared to a leaky house with little insulation (all other things equal…). And, these lower expenses are one reason an efficient house is more valuable.
This is where the tie to private mortgage insurance is particularly interesting. Generally, PMI is required for borrowers closer to the margin of eligibility, which typically includes borrowers with lower down payments and less in cash reserves. For this subset of borrowers, the reduction in energy expenses is more likely to be material to household budgets.
The funny thing about the mortgage market is that this kind of policy can be self-fulfilling. The fact that more energy efficient houses are more valuable is a basis for the policy and that’s likely to be an outcome of the policy. That is, the discount on mortgage insurance should allow some borrowers to pay more for energy efficient houses and increase demand for those houses. That is a good outcome. But it should remind lenders, investors, appraisers, and others how the current, conventional policy can be self-fulfilling in the opposite direction — loan policies that make it difficult for a borrower to borrow more to pay a premium for a more energy efficient house can inhibit the very evidence needed to support policy correction.
So, it’s great to have one more validation that more efficient houses are likely to be more valuable houses.
Click here for Genworth’s new form for the energy efficiency discount.
Click here for a very good article on the subject by Washington Post’s Ken Harney.
Photo Credit: Home Efficiency and Value/shutterstock