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How an FHA Energy Efficient Mortgage Works

How an FHA Energy Efficient Mortgage Works

    • Important FHA Energy Efficient Mortgage Considerations
    • Pros Cons
      • Add the cost of energy efficient improvements to your FHA loan when you buy a home or refinance your mortgage -- no need for a separate loan
      • Enables borrowers to qualify for a larger mortgage amount and afford more home
      • More flexible borrower qualification requirements (higher debt-to-income ratio)
      • Mortgage amount can exceed FHA loan limits
      • Borrower does not need to re-qualify or re-apply when improvements are added to the base FHA loan amount
      • Lower monthly utility costs and overall cost of owning a home
      • Improves property resale value
      • Potential to combine with other FHA programs including the FHA 203(k) Home Loan program for significant property renovations
      • Limits on value of energy efficient improvements
      • Borrower is required to pay up-front and ongoing FHA mortgage insurance premium (MIP)
      • Longer time frame to process and close mortgage
      • Requires additional work and involvement from lender which may limit the number of lenders that offer the program
    • FHA Energy Efficient Mortgage (EEM) Program Overview
    • The FHA Energy Efficient Mortgage Program, or FHA EEM, enables borrowers to add the cost of energy-efficient improvements to their FHA loan when they buy a home or refinance their existing mortgage. As long as the improvements are determined to be cost-effective according to program guidelines, borrowers do not need to re-apply or re-qualify for the larger, post-improvement loan amount. Additionally, for home purchases, the borrower is not required to make a larger down payment.

      The following example demonstrates the FHA EEM Program in action. A home buyer has been approved for a $190,000 FHA loan to buy a $200,000 home, which means the buyer is making a down payment of $10,000, or 5% of the purchase price. The buyer works with the lender and identifies $3,000 in energy efficient improvements that can be made to the property. The $3,000 is added to the buyer’s mortgage for a total loan amount of $193,000.  The buyer is not required to re-apply for the new, higher mortgage amount or increase his or her down payment. Buyers using the program are not required to re-qualify for the higher loan amount because the energy improvements reduce your monthly utility costs which frees up more money to pay your mortgage.

      As demonstrated by the example, an FHA Energy Efficient Mortgage enables borrowers to finance the cost of energy efficient home improvements without requiring a separate loan, such as a second mortgage, home equity loan, PACE (Property Assessed Clean Energy) loan or personal loan such as credit card debt. Adding the cost of the improvements to the mortgage saves the borrower significant time and money as compared to obtaining a separate loan or paying for the upgrades out of pocket. Additionally, the loan mortgage amount means the borrower benefits from a higher mortgage tax deduction benefit, especially as compared to paying for the improvements with a credit card or personal loan, which provide no tax benefit.

      Borrowers using the FHA EEM Program also benefit from other positive aspects of FHA mortgages including only requiring a down payment of 3.5% to buy a home and more flexible borrower qualification requirements as compared to conventional loan programs.  The ultimate objective of the FHA Energy Efficient Mortgage Program is to help you buy a better home by reducing your utility costs and making home ownership more affordable.

    • How an FHA Energy Efficient Mortgage Works
    • Select an FHA Energy Efficient Mortgage Lender

      Whether you are buying a home or refinancing your existing mortgage, the first step of the process is to work with a lender to get approved for an FHA mortgage. The lender reviews the property being financed as well as your credit score and financial profile to determine what size mortgage you qualify for, which is also known as the base loan amount. From the borrower’s standpoint, the involvement of the FHA is less important because you only interact with the lender when you apply for a FHA EEM loan. You can apply for the program with any FHA-approved lender such as a bank, mortgage broker, mortgage bank or credit union. Due to the required extra work and involvement, not all lenders offer the program so you may need to contact multiple lenders to find one that does.

      • Click on lenders below orFHA MORTGAGE RATES to compare FHA Energy Efficient Mortgage lenders
    • Compare FHA Mortgage Rates as of September 19, 2018
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    • Order Energy Assessment

      After you have selected a lender, the next step is to order a home energy assessment from a qualified energy assessor, auditor or rater to identify potential energy efficient improvements that can be made to the property.  Under FHA Energy Efficient Mortgage Program guidelines, the energy assessor must possess one of the following three certifications:

      • Building Performance Institute Building Analyst Professional
      • Building Performance Institute Home Energy Professional Energy Auditor
      • Residential Energy Services Network Home Energy Rater

      An energy report is required for all FHA EEM loans. The the cost of the report typically ranges from $500 to $800 and can be included in the loan amount.  You want to make sure to order the energy assessment early in the mortgage process as it can take some time to prepare and review.

      In addition to identifying energy efficient improvement opportunities, the energy assessor performs an analysis to determine the cost-effectiveness of the improvements. Only improvements that are determined to be cost-effective by the energy assessor according to program guidelines can be included in the energy package, which is the amount of additional funds added to the borrower’s loan amount to pay for the improvements.

      In short, to be considered cost-effective, an improvement must pay for itself over the life of the upgrade. For example, if you intend to use FHA Energy Efficient Mortgage proceeds to install a new water heater that costs $500 with a useful life of 10 years (120 months), the new water heater must reduce your utility bills by at least $4.20 per month to be cost-effective ($500 (cost of water heater) / 120 months = ~$4.20 per month). Basically, program guidelines require you to demonstrate that the improvements reduce your utility costs by at least as much as you paid for the improvements.

      After reviewing the energy report, the lender determines what energy efficient improvements can be added to the energy package and finalizes the revised, higher loan amount. Assuming there are no issues with the appraisal and title report, the mortgage eventually closes. Please note that the appraisal report is based on the pre-improvement value of the property so the borrower is not required to obtain an updated report after the upgrades have been completed like with other energy efficient mortgage programs.

      Mortgage Closes and Funds Are Released to Escrow Account

      When the mortgage closes, the money that is used to buy the home or refinance an existing mortgage is disbursed to the designated parties and the funds allocated for the energy package are placed in an escrow account. The buyer takes ownership of the property and has 90 days after the mortgage closes to use the funds in the account to pay for the improvements.

      The lender monitors the work and administers the escrow account to make sure the borrower has the funds to complete the upgrades when needed. Funds are released to the buyer after an inspection confirms the completion of each improvements and verifies that the anticipated associated cost savings will be realized. Buyers should keep copies of all receipts and invoices to document the work as it is completed.

      Energy Efficient Upgrade Project Completed

      When the energy efficient upgrades are completed, a final inspection is performed by the energy assessor, lender or an FHA inspector.  The lender then informs the FHA that the energy package has been implemented and that all funds in the escrow account have been disbursed. Any funds remaining in the escrow account after 90 days are applied to your outstanding mortgage balance.  At the conclusion of the FHA EEEM process, your home improvements should be completed and the escrow account should be depleted and closed.

    • FHA Energy Efficient Mortgage Energy Package
    • The FHA limits the amount of money that can be added to the base loan amount for energy improvements which is also known as the energy package. The amount of the energy package is limited to the lesser of:

      • The amount of the energy package based on the energy report; or
      • the lesser of 5% of:
        • the as-completed value of the property after improvements;
        • 115% of the area median home price (single family dwelling); or

      These guidelines can be somewhat difficult to follow so we present a couple of examples that demonstrate how they work.

      Example 1: $5,000 report-recommended energy package for home with $200,000 as-completed value in area with $190,000 median home price

      In the example below, the borrower can add the full $5,000 report-recommended energy package to the base loan amount. This is because the amount of recommended improvements does not exceed any of the other limits imposed by the FHA Energy Efficient Mortgage Program.

    • Report-Recommended Energy Package
      • $5,000
      5% of As-Completed Property Value
      • $10,000 (5% * $200,000)
      5% of 115% of Area Median Home Price
      • $10,925 (5% * 115% * $190,000)
      5% of 150% of Conforming Mortgage Limit
      • $33,982 (5% * 150% * $453,100)
      Allowable FHA EEM Energy Package
      • $5,000
    • Example 2: $15,000 report-recommended energy package for home with $200,000 as-completed value in area with $190,000 median home price

      In the example below, the borrower cannot add the full $15,000 report-recommended energy package to the base loan amount. This is because the amount of the recommended energy package is greater than 5% of the as-completed property value, which is $10,000. In this case the borrower can only add $10,000 to the base FHA loan amount to finance the recommended improvements.

    • Report-Recommended Energy Package
      • $15,000
      5% of As-Completed Property Value
      • $10,000 (5% * $200,000)
      5% of 115% of Area Median Home Price
      • $10,925 (5% * 115% * $190,000)
      5% of 150% of Conforming Mortgage Limit
      • $33,982 (5% * 150% * $453,100)
      Allowable FHA EEM Energy Package
      • $10,000
    • Please note that FHA EEM guidelines permit higher loan amounts to pay for the cost and installation of new solar or wind energy systems. Borrowers should consult their lender to determine the maximum loan amounts that apply to these projects.

    • What Energy Efficient Upgrades are Eligible for the FHA Energy Efficient Mortgage Program?
    • The program permits a wide range of energy efficient improvements including the following:

      • Air sealing (applying caulking and weather stripping)
      • Insulation
      • Air duct repairs, sealing or replacement
      • Smart thermostats and controls
      • Energy efficient windows and doors
      • Low-flow faucets and showerheads
      • Replacing hot water heater
      • Solar energy system
      • Wind energy system
      • Water-efficient toilet and shower
      • New heating, ventilation or air conditioner (HVAC) unit
    • FHA Energy Efficient Mortgage Requirements
    • Any borrower that meets the requirements for an FHA mortgage is eligible for the program. The good news is the borrower qualification requirements for an FHA mortgage are generally more lenient than for other programs.  We review the key FHA Energy Efficient Mortgage qualification requirements below.

      Credit Score

      For home purchases, the FHA EEM program requires a minimum credit score of 580 if you make a 3.5% down payment and a minimum credit score of only 500 if you make a down payment of at least 10%.  For refinances, the program requires a credit score of 580  if you have 2.25% equity in your home and a credit score of only 500 if you have at least 10% equity in your home.  The equity in your home is determined by the loan-to-value (LTV) ratio calculated by the lender.  The LTV ratio for an FHA EEM loan is based on the value of the property before energy efficient upgrades.  The minimum credit score required to qualify for the program is lower than for most other energy efficient mortgage programs, which means more credit-challenged borrowers are eligible for an FHA Energy Efficient Mortgage. We recommend that you review your credit score six months to a year before you start the mortgage process to address potential issues.  Please note that some lenders may apply their own minimum credit score requirement that is higher than the program guideline so be sure to check with your lender to determine their mortgage qualification requirements.

      Borrower Debt-to-Income Ratio

      Program guidelines apply a maximum borrower debt-to-income ratio of 43% to determine what size mortgage borrowers qualify for; however, the FHA EEM loans allow a higher debt-to-income ratio of 45% for mortgages on properties that meet certain energy efficiency standards (energy efficient homes). The higher debt-to-income ratio means that many program participants can qualify for a larger mortgage amount. Additionally, borrowers with special circumstances such as high credit scores, low loan-to-value (LTV) ratios or supplemental sources of income may be able to get approved for a mortgage based on a debt-to-income ratio of 50% or higher.

      First-Time and Repeat Home Buyers

      The FHA Energy Efficient Mortgage Program is available to both first-time and repeat home buyers.

    • Loan-to-Value Ratio (LTV) and Down Payment Requirements
    • Loan-to-Value (LTV) Ratio

      The maximum loan-to-value (LTV) ratio for an FHA Energy Efficient Mortgage is 96.5%.  The LTV ratio is based on the value of the property after energy efficient upgrades.  For example, if you want to buy a home with a pre-improvement value of $100,000, you could obtain a base loan of $96,500 (LTV ratio of 96.5%).  The amount of the energy efficient upgrades (energy package) is then added to both the base mortgage and property value.  Continuing the same example, if you want to make $5,000 in energy efficient upgrades to the home your final loan amount is $101,5000 ($96,500 + $5,000) and the post-upgrade property value is $105,000 ($100,000 + $5,000).

      Down Payment

      A borrower can use the program to purchase a property with a down payment as low as 3.5%.

    • FHA EEM Loan Amounts Can Exceed FHA Loan Limits
    • The standard FHA Program imposes loan limits on the size of mortgage you can obtain; however, these limits do not apply to the FHA Energy Efficient Mortgages. With the EEM program, your loan amount can exceed the FHA loan limit by the amount of the energy package.  For example, if the FHA loan limit in your county is $350,000 but you qualify for $25,000 in cost-effective energy efficient upgrades then your maximum possible mortgage amount is $375,000, which is above the loan limit.

      For reference, FHA loan limits vary by county and by the number of units in the property being mortgaged.  In the contiguous United States, the FHA loan limit for a single unit property such as a home or condominium ranges from $294,515 to $679,650 for high cost areas and the limit for a four unit property ranges from $566,425 to $1,307,175.  In Alaska, Hawaii, Guam and the U.S. Virgin Islands FHA loan limits range from $1,019,475 for a single unit property to $1,960,750 for a four unit property.

    • FHA Energy Efficient Mortgage Program Property Eligibility
    • One-to-four unit owner-occupied residences are eligible for the FHA EEM Program. Unlike other energy efficient mortgage programs, new construction homes are also eligible for the program.  Second and vacation homes and non-owner occupied investment properties are not eligible for the program.

      Using the FHA EEM Program to Buy a New Construction Home

      The program works a little different when used to buy a new construction home. First, the FHA applies a different criteria to determine if energy efficient improvements for a new construction home are cost-effective. With new construction properties, improvements are considered cost-effective if they exceed the standards set by the 2000 International Energy Conservation Code (IECC), as determined by the energy report.  Additionally, with new construction homes, the energy efficient improvements are completed when you take ownership of the property so there is no need to place energy package funds in an escrow account when your mortgage closes.

      Although implementing the FHA Energy Efficient Mortgage Program is different when you buy a new construction home as compared to an existing home, the end result is the same -- the program enables home buyers to afford a larger mortgage and more energy-efficient home.

    • Program Costs and Fees
    • Mortgage Rate

      For borrowers with good credit scores, FHA EEM mortgage rates are typically .125% - .500% lower than the interest rate for other conventional energy efficient mortgage programs and comparable to the rate for government-backed programs such as the VA EEM Program. The interest rate is lower because the program is backed by the government and borrowers are required to pay FHA mortgage insurance premium (MIP) which reduces the risk for lenders.  The lower the risk the lenders, the lower the interest rate.  Borrowers should shop multiple lenders to find the  lowest FHA Energy Efficient Mortgage rates and closing costs.

      Extra Costs

      In addition to standard mortgage closing costs, program applicants are required to pay extra fees for the energy assessment as as well as for any engineering and consulting work associated with the energy efficient upgrades, although many of these costs can be included in the mortgage amount.  Borrowers may also be required to pay extra lender, property inspection, escrow and title fees due to the additional work involved.

      FHA Mortgage Insurance Premium (MIP)

      Like with all FHA mortgages, borrowers with FHA EEM loans are required to pay an upfront and ongoing annual FHA Mortgage Insurance Premium (MIP).  The MIP pays for mortgage insurance that protects the lender in the event you cannot pay your mortgage and default on your loan.  The upfront fee for most FHA loans is 1.75% of the mortgage amount and can be added to your loan.  The ongoing fee is similar to private mortgage insurance (PMI) and is an additional monthly cost for the borrower. The amount of ongoing MIP depends on mortgage amount, loan-to-value (LTV) ratio and mortgage length.

    • Mortgage Type and Program
    • Mortgage Program

      The program applies to 15 year and 30 year fixed rate mortgages and selected adjustable rate mortgages (ARMs).  Interest only mortgages are not eligible.

      Mortgage Type

      The FHA Energy Efficient Mortgage Program applies to both home purchase mortgages as well as refinancings. Cash-out refinancings are not permitted.

    • Combining an Energy Efficient Mortgage with Other FHA Programs
    • The FHA EEM Program is an “add-on” that can be used with the standard FHA Mortgage Program and the FHA 203(k) Home Loan Program. The FHA 203(k) Program enables borrowers to include funds for major property renovations or remodeling in their loan amount. The differences between the FHA 203(k) Program and the FHA Energy Efficient Mortgage Program are that the 203(k) Program allows for a much larger portion of loan proceeds to be allocated to property renovations, the improvements are not limited to energy efficient upgrades and strict loan limits apply. Using the FHA EEM and 203(k) programs together enables borrowers to exceed FHA loan limits and finance the energy efficient improvements that are part of a larger home renovation project.

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