How the Mortgage Industry Works
Not only is buying a home the largest single purchase most families make, it is also one of the most complicated. That is why the average home buyer depends on a network of housing professionals to help guide him through this cumbersome process. Real estate companies, loan originators, loan underwriters, appraisal firms, primary lenders and secondary mortgage institutions: all have a stake in the selling and financing of the nation's homes and each plays a crucial role in the success of home energy rating/energy mortgage programs. Understanding how the mortgage industry works is essential to the design and implementation of a successful home energy rating program.
Housing Industry Priorities
First, it is important to realize that saving energy is not the primary concern to the industry. The home builder focuses on building a home the buyer is willing to pay for. The real estate agent's primary motivation is to market a home for the quickest possible sale. The lender in the transaction makes money by financing the residential purchase in as secure a manner as possible. Determining market value of the home is the priority of the appraiser. Home energy rating systems and energy mortgages can bridge all of these interests while fostering an increased demand for energy efficiency from consumers.
Generally, a real estate agent or loan originator is the first point of contact for a consumer interested in purchasing a home. Most home buyers depend on these industry professionals to locate the home that meets their needs and advise them about their financing options. Ideally, the seed for taking advantage of a home energy rating or an energy mortgage is planted right away by either or both of these sources. Since real estate agents and loan originators get paid on a commission basis, adding energy efficiency into the mortgage increases their return for a transaction. However, volume and a fast turnaround are also vital to their livelihood, so the home energy rating and energy mortgage process must be quick and easy to win their critical advocacy.
Ask most home owners what kind of home mortgage they have and they will tell you the name of the bank or credit union where they applied and qualified for the loan. However, in the professional mortgage field, the local lender, the one who has the direct contact with the community, is generally considered the primary lender.
Secondary Mortgage Markets
Because the mortgage industry requires a large volume of sales to minimize the risk of default, primary lenders work with major financing sources known as the secondary mortgage market to access the funds necessary to finance home loans throughout the nation. The secondary mortgage market buys and sells mortgage loans in large lots on a national basis. By handling mortgages in huge quantities, and hence reducing risk, the secondary mortgage markets can offer competitive benefits, such as lower interest rates, and still make targeted profit margins because of the high volume. Primary lenders can offer their borrowers a broad menu of mortgage options by taking advantage of programs offered by the secondary mortgage market.
There are two main components of the secondary mortgage market: "government" and "conventional" markets. Government markets generally offer attractive terms to meet social needs, such as lower and middle class families or veterans purchasing their first home. Under the structure of government markets, the government assumes a large portion of the risk for lending the money. This assurance gives the primary lenders greater freedom and flexibility when making the loans and allows families, who might not otherwise be eligible, qualify for a home purchase. The two general types of government markets are state and national. The state level is generally state housing finance agencies. State housing finance agencies use the full faith and credit of a state government and IRS tax codes to offer attractive interest rates to first time home buyers and veterans. The national markets, including the U.S. Department of Housing and Urban Development's Federal Housing Administration (FHA), the Department of Veterans Administration (VA) loan program and the Department of Agriculture's Farmer's Home Administration (FmHA) loan program, insure and guarantee mortgages which meet national priorities. Since these loans are guaranteed and insured by the federal government, the risk to lenders is reduced, but eligibility for these loans is restricted by income, geographic region and/or the price of the home. FHA loans exemplify government-insured loans. Those made by the VA are examples of government-guaranteed loans. FmHA guarantees and insures loans in rural areas and small towns.
There also two types of conventional mortgage markets. The largest are federal government- chartered institutions: Fannie Mae, Freddie Mac and Ginne Mae. A majority of loans made in America are purchased by these institutions. In fact, Fannie Mae is one of the largest corporations in America, with a volume of more $350 billion in mortgage loans a year. The other market category is loans kept within the private lending institution or held by a large private lender, often referred to as "jumbo loans". The conventional market reduces the
risk to the primary lender by buying all or part of the firm's mortgage loan portfolio. The purchased loans are then packaged into mortgage-backed securities and sold on the bond market.
As the underwriter for most of the country's mortgage loans, the secondary mortgage market is where energy mortgages must be initiated. Primary lenders will not sell energy mortgages, unless they know the secondary mortgage market is a willing partner in the process. Fortunately, both the government and secondary components of the secondary mortgage market recognize the benefits of creating and supporting programs which allow the financing of residential energy efficiency features through the mortgage loan. However, home buyers in states without home energy rating systems, which are recognized and accepted by the secondary mortgage market, rarely qualify for energy mortgage programs.
Tools to Add Value for Efficiency
After the loan originator initiates a loan, the primary lender uses a loan underwriter and an appraiser to ensure the borrower meet market risk criteria. The loan underwriter certifies the borrower has met the necessary credit qualification for the applicable secondary mortgage market program. The debt-to-income ratio stretch feature of an energy mortgage allows an underwriter greater flexibility in qualifying a borrower to purchase an energy efficient home.
The appraiser evaluates the value of the property and compares it with similar houses in the neighborhood. A lender can only finance a portion of the home's market value. The market value of the home must be high enough to assure the primary and secondary lenders that their institutions will not lose money if the lender forecloses and the property is repossessed. If the appraisal does not place value on a feature of a home, it cannot be financed, and the buyer must pay the added costs out of pocket, thus increasing the down payment. Because of this, an appraiser bases the appraised value on the home's market value and not price.
Appraisers use several tools when determining the market value of a home. The first is the Multiple Listing Service (MLS). The MLS is a listing of all the homes in a community being offered through real estate agents. Real estate agents use the service to assist in locating homes according to location, price range, special features and other consumer preferences. The MLS also tracks the sales of homes. Appraisers use the service to identify homes similar to the those being appraised to use in cost comparisons. The local appraisal institute's computerized data base is another useful tool. This data base contains information on homes that have been appraised. Appraiser members can access this information for comparison purposes and to establish market trends.
Traditionally conservative in giving dollar-cost benefits to housing design innovations, appraisers have been slow to recognize and credit the energy efficient features of homes in the appraisals. A primary reason has been the lack of market data showing how energy efficient features of a home influence the sales price. For that reason, establishing an industry-backed standard method of measuring and labeling the relative energy efficiency of a home is vital.
It's the Key!
A home energy rating system is the answer. A rating presents data about a home's efficiency in terms all facets of the industry, as well as consumers, can understand. Rating information can be added to and easily tracked through the MLS and appraisal data base. The rating gives appraisers the data they need to add value for increased efficiency.
The rating system information has become integral to the housing market in Alaska. A home's energy rating is included in the MLS and the state's appraisal institute data base. Because of this market data, appraisers routinely add value for higher rated homes. Other states are taking steps to incorporate the collection of this market data. The rating systems in Colorado and Rhode Island now include in the MLS.
However, even with the quantitative measurement provided by a home energy rating, energy efficiency may continue to be appraised conservatively until enough data is collected to demonstrate the added value stands up when the energy efficient home is resold. There are several ways to help expedite this process. The first is to educate the appraisal industry about how the rating system works and how the appraiser can use the energy rating to add or subtract value. The second method is to create a transition period during which a home energy rating system can capitalize the energy efficiency above the appraised value. Fannie Mae, Freddie Mac and FHA all allow this through the form 70A addendum to the standard appraisal form. However, this form is seldom used.
By its very complexity, the mortgage market challenges the introduction of new ideas and concepts. Each tier of the professional network must be educated about the benefits of energy mortgages to both their industry and their clients before energy mortgages become institutionalized. The adoption of a common method of measuring the relative energy efficiency of a home - the home energy rating system - is the first, vital step to meeting that goal.