Understanding Energy Efficient Mortgages

As rising energy costs continue to plague homeowners, the FHA offers an incentive to buy energy efficient homes: energy efficient mortgages (EEM). An EEM applies to homes that include energy saving improvements. The savings that homeowners reap in utility costs is considered in the mortgage payment allowing buyers to boost their buying power.

The FHA energy efficient mortgage program allows borrowers to finance the costs of upfront, cost effective energy saving equipment including active and passive solar systems. The principle behind these mortgages is that while buyers may not have the capital to implement energy efficient systems, the savings over the lifetime of the equipment means they can devote more income to mortgage payments.

The program has been available in all 50 states since 1995 and is an exciting way for homeowners who otherwise could not afford energy efficient choices to tap into the green building trend. Not only an economically viable choice, energy efficient mortgages promote building practices that are environmentally sound, decreasing pollution and overuse of natural resources.

Borrowers are approved for EEMs through FHA guidelines and eligible properties are 1-2 unit existing and new construction. The eligible energy saving improvements cost that may be financed into the mortgage is the greater of either 5% of the property’s value up to $8,000 or $4,000.

The cost of the improvements must not exceed the current value of the expected energy savings. This balance is determined by a consultant using the home energy rating system (HERS). This program helps homeowners identify cost-effective strategies for energy improvement.

Home energy ratings are comprehensive and standardized. Through an inspection of building elements like insulation, windows, solar and HVAC systems, raters run a computer analysis that generates estimated savings. The home is given a score between 1 and 100 and then this is equated with a “star” rating between 1 and 5, 5 being the most energy efficient.

The rating also estimates costs for heating, cooling, hot water, lights, appliances and electricity, costs of improvements and projected annual energy savings. Energy saving improvements can be prioritized in order of most cost-effective.

A HERS consultation typically runs about $250 and can be financed into the loan. The energy rating must be done by an independent party with no relation to either buyer or seller. The report must be in writing and describe all energy related features including insulation, infiltration (drafts from unconditioned air), weather seal elements such as weatherstripping and caulking, thermal capacity of windows and doors and details of the heating, cooling and hot water systems.

The HERS report also needs to detail recommended energy saving improvements and the installation and operating costs. Also, the estimated utility costs prior to improvements and estimated utility costs after upgrades.

The funds for the energy saving improvements are held in escrow until the loan closes. Once the improvements are completed in accordance with the HERS report, the money is released to the owner. EEMs can even be used in refinance situations if the new mortgage terms, including the energy efficient improvements, create a monthly payment less than the previous mortgage.

Bottom line, EEMs give homeowners the ability to improve their home’s energy efficiency whether buying, building or refinancing.