FHA Energy Efficient Loan Pros and Cons
An FHA energy efficient loan is an add-on to other FHA programs but the borrower is not required to re-qualify for the loan when they add the cost of the upgrades to the base loan amount. So the FHA EEM Program enables borrowers to obtain a larger loan to pay for energy efficiency improvements without having to re-apply for the mortgage.
An FHA EEM offers borrowers multiple benefits including financing energy efficiency improvements with one loan, more flexible borrower qualification requirements, requiring a low down payment or equity position as well as the ability to lower your utility costs and increase your property value. Program disadvantages include a limit on the amount of loan proceeds that can be used for energy efficiency improvements, the added cost of mortgage insurance premium (MIP) and extra closing costs.
We review the full list of pros and cons for the FHA Energy Efficient Mortgage Program below. Borrowers should understand both the positives and negatives of an FHA energy efficient loan to determine if it is the right green mortgage program for them.
FHA Energy Efficient Mortgage Pros
Finance a Home Purchase or Refinance Plus Major Energy Efficiency Upgrades with One Mortgage
An FHA energy efficient loan enables you to finance the purchase of a home or refinance your mortgage and include the cost of significant energy efficiency upgrades with one loan as opposed to arranging a mortgage plus a second mortgage, home equity loan, line of credit (HELOC) or PACE loan to finance the upgrades. Using a single FHA mortgage instead of two separate loans streamlines the financing process and saves you money and time. The FHA EEM Program offers borrowers a faster and more cost-effective solution to financing energy efficient improvements when they buy or refinance a home.
Borrower Not Required to Re-Qualify When Cost of Improvements is Added to Loan Amount
With an FHA energy efficient loan borrowers are not required to get re-qualified or re-approved when they add the cost of energy efficient upgrades to their base FHA loan, as long as the upgrades are determined to be cost-effective. Additionally, borrowers are not required to make a larger down payment when using the FHA EEM Program to buy a home. For example, if a borrower is approved for a $90,000 FHA loan to buy a $100,000 home, the borrower can add $5,000 in energy efficiency upgrades to the loan for a total loan amount of $95,000. The borrower is not required to re-qualify for the new, higher loan amount or increase his or her down payment because the energy efficient upgrades lower your monthly utility bills which improves your ability to afford your mortgage.
Increase Property Value and Lower Utility Bills
Energy efficiency home upgrades provide multiple benefits to home owners including reducing your energy bills while also boosting your property value. For example, using an FHA energy efficient loan to install solar panels lowers your monthly energy expenses and also increases the value of your home. Even small energy efficiency improvements such as adding a low-flow irrigation system or installing weather stripping can save you money on your water and gas bills and lift your property value. In order to qualify for the FHA EEM Program an energy efficient improvement must pay for itself over the life of the upgrade, which means it should save you money on utility costs. Plus, in many cases energy efficient improvements increase your property value more than other home remodeling projects. Borrowers can use an FHA energy efficient loan to reduce their monthly bills in the near term and increase their property value in the long run.
More Flexible Borrower Qualification Requirements
FHA mortgage programs use more flexible borrower qualification requirements including a lower minimum required credit score and a potentially higher debt-to-income ratio. The minimum credit score required to qualify for the FHA Energy Efficient Mortgage Program is 580 if your down payment is between 3.5% and 10.0% of the property purchase price and only 500 if you put down at least 10%. Additionally, although the standard debt-to-income ratio limit for the FHA program is 43% (similar to other programs), the FHA EEM Program permits a higher debt-to-income ratio of 45% for homes that meet certain energy efficiency standards. The debt-to-income ratio represents the maximum percentage of a borrower's monthly gross income that can be spent on total monthly housing expense (mortgage payment plus taxes and insurance) plus other monthly debt such as credit card, student and auto loans. A higher debt-to-income ratio means program participants can qualify for a larger loan amount.
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Ability to Exceed FHA Loan Limits
Mortgages obtained through FHA Programs are usually subject to loan limits but these limits do not apply to FHA energy efficient loans. With the FHA Energy Efficient Mortgage Program, your mortgage amount can exceed the FHA loan limit by the amount of energy efficient upgrades you qualify for. For example, if the FHA loan limit in your county is $300,000 but you qualify for $10,000 in cost-effective energy efficient upgrades then your maximum possible mortgage amount is $310,000, which is above the loan limit. By enabling borrowers to exceed loan limits, the FHA Energy Efficient Mortgage Program allows applicants to qualify for larger mortgages.
Ability to Combine with Other FHA Mortgage Programs
An FHA energy efficient loan is an "add-on" that is combined with other FHA mortgage programs such as the FHA Home Loan and FHA 203(k) programs. The standard FHA Home Loan Program enables borrowers to buy a home with a low down payment. The FHA 203(k) Mortgage Program enables borrowers to include funds for major home renovations or remodeling in their loan amount. Borrowers can combine an FHA energy efficient loan with the FHA 203(k) program to finance the cost of energy efficient upgrades that are part of a larger home remodeling or rehabilitation project.
Low Down Payment / High Loan-to-Value (LTV) Ratio
The FHA Energy Efficient Mortgage Program only requires that borrowers make a down payment of 3.5% of the property purchase price or the case of a refinance, borrowers are only required to have 3.5% equity in the property, which implies a loan-to-value (LTV) ratio of 96.5%. The required down payment or equity position of 3.5% is lower than the 10% - 20% required by other standard mortgage or home improvement loan programs and lower than the 5.0% down payment required by the Fannie Mae HomeStyle Energy Program. Requiring a low down payment when buying a home or equity position when refinancing makes an FHA energy efficient loan an ideal home financing alternative for borrowers who struggle to save money to buy a home or who have limited equity in their home.
FHA Energy Efficient Mortgage Cons
Limit on Amount of Loan That Can Be Used for Energy Efficient Upgrades
The FHA EEM Program limits the amount of loan proceeds that can be used for energy efficient upgrades, which is also called the energy package. The permitted amount of the energy package is the lessor of the amount of the energy package as determined by a certified energy auditor or the lesser of 5% of: 1) the as-completed property value after upgrades; 2) 115% of the area median home price; or, 3) 150% of the conforming loan limit ($726,200 for a single unit property in most counties). The FHA EEM Program permits higher loan amounts to finance solar power or wind energy systems. The amount of upgrades permitted with an FHA energy efficient loan is usually lower than other green mortgage programs such as the Fannie Mae HomeStyle Energy Program. Borrowers should work closely with their lender to understand the amount of energy efficient home upgrades that can finance with the FHA Energy Efficient Mortgage Program.
FHA Mortgage Insurance Premium (MIP)
FHA Energy Efficient Mortgage Program participants are required to pay an up-front and ongoing monthly FHA mortgage insurance premium (MIP). FHA MIP pays for insurance that protects lenders in the event that borrowers default on their mortgage. Although it can be added to the loan amount, the upfront MIP increases your closing costs while the ongoing monthly fee increases your total monthly housing expense. The upfront FHA MIP for most mortgages is 1.75% of the loan amount while the ongoing fee depends on the loan amount, loan-to-value (LTV) ratio and mortgage term. MIP is an extra cost that borrowers do not pay with standard mortgage programs although many low or no down payment mortgage programs require borrowers to pay monthly private mortgage insurance (PMI). Unlike FHA MIP, however, PMI does not require an upfront fee and is removed when the loan-to-value (LTV) ratio falls below 78% as borrowers pay down their loan balance or the value of their home increases.
Higher Closing Costs and Longer Mortgage Closing Timeline
Borrowers are required to provide lenders a detailed plan, called an energy package, that itemizes the energy efficiency upgrades they want to make to a property. The plan outlines the estimated cost of the upgrades and quantifies the anticipated cost savings associated with each improvement to make sure they pay for themselves over the life of the upgrade, according to FHA EEM guidelines. Borrowers are required to obtain an energy report or assessment from a qualified energy assessor, auditor or rater to identify and document the upgrades. An energy report or assessment is required for all FHA energy efficient loans, no matter the amount of upgrades borrowers want to make. Obtaining the energy report adds time and cost to the home loan process. For example, an energy report from a qualified assessor or auditor typically costs $500 - $800, although the cost can be added to your mortgage amount. Additionally, due to the extra work required to process an FHA energy efficient loan, most lenders charge a higher origination fee which is an extra closing cost for borrowers. Applicants should fully understand any additional lender or third party closing costs before selecting an FHA EEM lender.
More FREEandCLEAR Resources
FHA Energy Efficient Mortgage Guide
Review our comprehensive overview of the FHA Energy Efficient Mortgage Program including borrower qualification requirements and other important program information such as property eligibility, energy efficiency improvement project guidelines and loan limits.
FHA Mortgage Rates
FHA energy efficient loans are provided by traditional lenders such as banks, mortgage banks, mortgage brokers and credit unions. Use our FHA rate table to find lenders that offer the FHA Energy Efficient Mortgage Program and to review updated FHA mortgage rates and fees for lenders in your area. Comparing rates from multiple lenders is the best way to save money on your mortgage.
Summary of Energy Efficient Mortgage (EEM) and Green Mortgage Programs
Review and compare important program features and eligibility requirements for multiple energy efficient mortgage (EEM) and green mortgage programs so that you can select the mortgage option that is right for you.
FHA Loan Calculator
Use our FHA Mortgage Calculator to determine what size FHA loan you can afford based on your income and debt. The calculator also indicates the FHA loan limit in your county as well as the upfront and ongoing FHA mortgage insurance premium (MIP) based on your mortgage amount and loan-to-value (LTV) ratio.
Sources
"FHA Programs That Can Help Homeowners Finance Energy-Saving Improvements." Federal Housing Administration. U.S. Department of Housing and Urban Development, 2020. Web.