Energy efficiency is all the rage, but it’s not cheap. This article guides you through the FHA’s energy efficient mortgage (EEM) program, and includes a list of EEM lenders doing business in California. Stay tuned for articles about similar programs under Fannie Mae, Freddie Mac and the VA.
Homebuyers and homeowners have a way to finance energy efficient improvements under the Federal Housing Administration’s (FHA’s) Energy Efficient Mortgage (EEM) program. The EEM program was initially adopted as a pilot program in 1995, then expanded nationally.
The underlying idea behind the EEM program is this: reduced utility charges allow buyers and owners (to simplify, we’ll call them “applicants” in the remainder of the article) to make higher monthly mortgage payments to fund the cost of the energy efficient improvements.
Financeable energy efficient improvements funded under FHA’s program include:
- purchasing energy efficient heating and cooling systems;
- installing solar panels;
- installing energy efficient windows;
- installing wall or ceiling insulation; and
- completing repairs of existing systems to improve energy efficiency.
Under the EEM program, the costs of fundable energy improvements are added to the base FHA maximum mortgage amount on a purchase or refinance. [HUD Mortgagee Letter 2009-18]
Applicants first qualify for an FHA-insured loan. Applicants need to make a down payment of at least 3.5% of the property’s sales price or appraised value. The up-front mortgage insurance premium (MIP) may be financed by adding it to the mortgage amount.
The EEM program adds no further qualifications or down payment requirements. To encourage energy efficiency, more permissive standards apply depending on the property. [See the “EEM underwriting” subhead below]
Like most FHA loan programs, the EEM is not funded by the FHA. It is funded by a lender, and insured to guarantee repayment by the FHA.
An EEM may be used in connection with either an FHA-insured purchase or refinance mortgage (including streamline refinances), under the:
- “standard” 203(b) program for one-to-four unit residential properties;
- 203(k) rehabilitation program;
- 234(c) program for condominium projects; and
- 203(h) program for mortgages made to victims of presidentially declared disasters. [HUD Handbook 4155.1 Chapter 6.D.2.a]
The EEMs come with additional property requirements.
Eligible property types include new and existing:
- one-to-four unit residential properties for the 203(b) and 203(k) programs;
- one-unit condominiums; and
- manufactured housing. [HUD Handbook 4155.1 Chapter 6.D.2.a]
Properties are only eligible if the total cost of the energy efficient improvements is less than the present worth of the energy charge reductions during the improvements’ useful lives. The cost and estimates of the energy savings are calculated and reported by a home energy rater using the home energy rating system (HERS) system.
To prepare the report, the home energy rater completes a physical inspection of an existing property, or reviews the plans and specifications of a home to be built. The home energy rating report is delivered to the applicant (whether homebuyer or homeowner) and the lender. [HUD Handbook 4155.1 Chapter 6.D.3.a]
Editor’s Note — The home energy rater is an independent third-party entity. They may not be affiliated with the seller, the applicant or the contractor who will be making the energy efficient improvements. [HUD Handbook 4155.1 Chapter 6.D.2.h]
The cost of the inspection and related fees may also be added to the mortgage amount.
The set of improvements agreed to by the applicant based on the HERs report is called the energy package.
The home energy rating report
The home energy rating report for the energy package is to include:
- the address of the property;
- the name of the applicant;
- the FHA Case Number;
- the name of lender (if applicable);
- the type of property;
- whether the property is new construction or existing;
- the date of the physical inspection of the existing property or, for new construction, the date of the plan review;
- a description of the current energy features of the property, or proposed features if new construction, to include:
- a description of the insulation R values in ceilings, walls, and floors;
- infiltration levels and barriers (caulking, weather-stripping, and sealing);
- a description of the windows (storm windows, double pane, triple pane, etc.) and doors; and
- a description of the heating (including water heating) and cooling systems;
- a description of the improvements noted in the energy package;
- the estimated cost to install the energy package improvements, the useful life, and the costs of any maintenance over the useful life of the improvements;
- for existing homes, the estimated present annual utility charges before the installation of the energy package;
- for new construction, the estimated annual utility charges of a reference house built to 2000 International Energy Conservation Code (IECC);
- the estimated expected annual utility charges after the installation of the energy package;
- the estimated annual savings in utility charges after installation of the energy package improvements, including the present value of the savings;
- the names and signatures of the person(s) who inspected the property and of the person(s) who prepared the report, and the date the report was prepared; and
- the following Certification, signed by the person(s) who inspected the property and the person(s) who prepared the report:
- “I certify to the best of my knowledge and belief, the information contained in this report is true and accurate and I understand that the information in this report may be used in connection with an application for an Energy Efficient Mortgage to be insured by the Federal Housing Administration of the U.S. Department of Housing and Urban Development.” [HUD Handbook 4155.1 Chapter 6.D.3.b-c]
As previously stated, the EEM funding is an “add-on” to existing FHA-insured loans. Thus, the applicant starts by applying for, say, a 203(b) purchase loan. The 203(b) loan is underwritten as if the energy package did not exist.
Exceptions exist for:
- new construction; and
- existing properties built or retrofitted to 2000 IECC standards.
For EEM properties, applicants can “stretch” the allowable debt-to-income ratios (DTIs) to 33% front-end/45% back-end (for the standard 203(b) program, it is 31% front-end mortgage payment/43% back-end comprising payments on all debts).
Additionally, on new construction, the applicant’s qualifying ratios are calculated as the sales price MINUS the cost of the energy package. The builder has already included the cost of the improvements in the contract price.
For example, consider the sales price of a newly constructed property is $200,000. The energy package costs $6,000. The applicant makes a 3.5% down payment of $7,000. For purposes of calculating the applicant’s qualifying ratios, both the energy package cost ($6,000) and the downpayment ($7,000) are subtracted from the sales price.
Thus, the applicant’s qualifying ratios are based on a $187,000 loan amount. Further, the applicant’s maximum allowable DTI can be stretched to 33%/45%. [HUD Handbook 4155.1 Chapter 6.D.2.b]
Once the lender has determined the applicant and the property qualify for the FHA-insured mortgage, the lender will use the home energy rating report and an EEM worksheet to determine the energy package funding to be added to the base loan amount.
The total dollar amount of fundable energy efficient improvements is the lesser of:
- the dollar amount of cost-effective energy improvements, plus the cost of reports and inspections; and
- the lesser of 4% of:
- the value of the property;
- 115% of the median area price of a single family dwelling; or
- 150% of the conforming Freddie Mac limit. [HUD Mortgagee Letter 2009-18]
To extend our prior example, the costs for the energy package are $6,000. The reports and inspections cost another $200, for a total of $6,200.
The property value (we’ll align it with the sales price) is $200,000. 115% of the median area price is $220,000, and 150% of the conforming Freddie Mac limit is $625,500. Thus, 4% of the lesser of those amounts ($200,000 value) is $8,000.
In our scenario, assuming the applicant’s DTI allows it, the $6,200 is the amount of the EEM.
A second appraisal is not required. Additionally, any appraisal completed on the property is not required to reflect the value of the energy package. [HUD Handbook 4155.1 Chapter 6.D.2.c]
On new construction, a separate escrow is not required for the energy package funds, as the improvements are already included in the construction contact price to be paid. In this case, the EEM gives the applicant extra purchasing power to pay for the new construction and its energy efficient improvements. Thus, builders are the primary beneficiary of this program.
On existing properties, the lender places the funds for the energy efficient improvements in an escrow account at loan closing. The money is released to the applicant after an inspection verifies the improvements have been installed and energy savings will be achieved. Any funds remaining after the construction period are to be applied to the loan principal.
If the energy package is part of a Section 203(k) rehabilitation loan, the escrowed amounts are to be included in the rehabilitation escrow account.
When an additional escrow account is required, the lender is responsible for filling out form HUD 92300, Mortgage Assurance of Completion, to indicate the required escrow has been established. [HUD Mortgagee Letter 2005-21]
The lender is also responsible for administering, or arranging for administration of the escrow account. [HUD Handbook 4155.1 Chapter 6.D.1.d]
On new construction, the energy package has already been included in the cost of the house. Thus, there are no installations to be completed.
On existing construction, the energy package is to be installed within 90 days of the loan closing (180 days are allowed for Section 203(k) rehabilitation mortgages).
If the work is not completed within the required timelines, the EEM funds are to be applied to the loan principal. The applicant may not be paid for labor, or receive cash back from the EEM funds. [HUD Mortgagee Letter 2005-21]
Upon completion: inspection and notification
The final inspection to ensure all energy efficient improvements have been made may be completed by the lender, the home energy rater or an FHA fee inspector. The applicant may be charged for this final inspection.
The lender is responsible for informing the FHA the energy package has been completed, and that escrow has disbursed all funds and closed.
FHA lenders who already have a direct endorsement from FHA do not need any additional qualifications to offer EEM loans. However, despite this program having been around for almost 20 years, it’s still difficult to find a lender who offers the program. Why?
On existing properties, the lender has additional responsibilities in connection with the escrow account on these types of loans. Since homeowners seldom use the EEM loans, the initial learning curve for offering EEMs may simply present too much of a cost-benefit barrier for most lenders.
first tuesday reporters called over ten sources that advertised EEMs in California, but only three actually offer EEM programs:
Dean Adams Home Loans
Home state: California
Mission Hills Mortgage
Home state: California
Cornerstone Home Lending, Inc.
Home state: Texas
Editor’s note — Some of these lenders may offer EEM programs under Fannie Mae, Freddie Mac or the U.S. Department of Veterans Affairs (VA).
As more homebuyers and homeowners seek ways of mitigating increasing energy costs, this program may finally enjoy its day in the sun.