What are green mortgages and could they increase the energy efficiency of UK homes?
The UK Government’s Clean Growth Strategy, released last year, included plans to work with lenders to develop “green mortgage products” that “take account of the lower lending risk associated with more efficient properties and the reduced outgoings for customers living in more efficient homes”.
The Government hopes to use green mortgages to incentivise people to make their homes more energy efficient. Banks might be willing to offer more favourable terms, like lower interest rates, to owners of energy-efficient homes if they are less likely to default on their mortgage payments.
However, more research is needed to determine whether green mortgage products actually do have a lower lending risk, as the Clean Growth Strategy asserts.
The Government take a more nuanced approach in other documents, notably in their call for evidence on building a market for energy efficiency. They call for more research on green mortgages as one component of an overall strategy to encourage energy efficiency. The Government should take its own advice and make sure their approach is internally consistent.
What are ‘green mortgages’?
At the moment, there is no universal definition of green mortgages, but they usually refer to mortgages on energy efficient homes.
It might be useful to expand this definition to include climate resilience as well as energy efficiency. We discuss this more in the second part of this two part series on green mortgages.
The reasoning behind promoting green mortgages is that owners of energy-efficient homes might be less likely to default on their payments. Since energy efficiency lowers energy use, energy-efficient homes should have lower bills. This might make the homeowners less likely to default on their mortgage payment because their disposable income will be larger. The reasoning is intuitive, but we do not have a lot of hard evidence to draw from.
More evidence on green mortgages for the UK is needed
One interesting study from the US by the non-profit ‘Institute for Market Transformation’ is often cited – including on page 43 of the Government’s call for evidence on building a market for energy efficiency. The IMT study finds that owners of energy efficient homes are 32% less likely to default on their mortgage payments. It is a very promising initial result but needs more support to make a convincing case for a causal link between energy efficiency and lower risk of mortgage default.
Other explanations for the results are possible. For instance, higher-income households are both more likely to buy energy-efficient homes and less likely to default on their mortgage payments in general. The US researchers tried to account for income but they were partially limited by the availability of data.
Besides the data limitations, it is difficult to draw conclusions from the IMT study for the UK mortgage market. While the U.S. data set included only owner-occupied homes, the UK has a booming buy-to-let market. This could make a difference to the results. Landlords do not benefit directly from reduced energy bills from energy efficiency measures – the tenants do. So the link between reduced bills and reduced mortgage defaults is less clear for landlords and buy-to-let mortgagors.
The IMT study is an interesting piece of initial research on green mortgages. However, we must replicate the results in the UK before taking it as a given that energy-efficient households are less likely to default on their mortgages. The call for evidence on Building a market for energy efficiency acknowledges this, noting that “it can be difficult to untangle the role of the property from the homeowner in these calculations” and suggesting additional research in the UK as a first step.
Shades of green: Are mortgages either green or not green?
Labelling mortgages either green or not green is not the only option. The UK Government could also encourage banks to take account of energy efficiency in all mortgages they offer.
For example, banks could consider energy efficiency bands as part of their affordability calculations. This is the approach favoured by the UK Green Building Council, for example, whose Government-supported LENDERS project suggests collecting more information during the mortgage application process to help determine the terms of the loan. The project suggests, for example, that buyers of energy efficient homes (according to EPC certificates) would be eligible to borrow more from the bank. This could result in an increased demand from buyers for energy-efficient properties.
Bank could consider energy efficiency bands as part of the borrower’s overall profile for credit risk, instead of considering all green mortgages as safer across the board. This could be a safer and more flexible alternative to offering more favourable interest rates for green mortgages. It encourages banks to consider energy efficiency alongside other borrower characteristics.
Green mortgages are only part of the equation for encouraging energy efficiency
Beyond the use of mortgage products, the UK Government should also look at other ways of encouraging energy efficiency. As highlighted in the UK Government’s call for evidence on building energy efficiency, household access to financing is not the only barrier to energy efficient homes.
Homeowners may also feel discouraged from investing in energy efficiency measures by other factors: a lack of awareness; the level of hassle involved in making home improvements; the length of time for energy saving measures to ‘pay back’ the cost paid out in their installation; and by the mismatched incentives between tenants and landlords, where the person making the investment is not necessarily the one reaping the rewards.
The dangers of a poorly-designed scheme are evident from the lack of take-up of the UK Government’s Green Deal scheme in 2012. The scheme offered low-cost loans to incentivise energy efficiency improvements, but was scrapped in 2015 due to a lack of demand. The response to the Green Deal was muted in part because of the interest rates were insufficiently attractive, but also because of a lack of awareness of the scheme and uncertainty around the energy savings involved.
The Government’s calls for evidence on the Green Deal and on building a market for energy efficiency is a positive sign that they are looking to learn from the past, and the Government’s Clean Growth Strategy should follow suit. It is important to keep a sense of perspective, then, that green mortgages will not be a silver bullet, They need to be well-defined, well-designed, and part of a coherent overall strategy on energy efficiency.
This commentary is the first of a two part series on green mortgages. The second part of this series will be published tomorrow. The views expressed in this commentary are those of the author and not necessarily those of the Grantham Research Institute.