The Federal Housing Administration will stop insuring new mortgages on homes with PACE loans, a type of financing used to fund energy-efficient home improvements.
The announcement Thursday followed criticism from consumer groups that too many borrowers have taken out unaffordable loans for solar panels and other projects after contractors misrepresented how the financing works.
In announcing the policy change, the FHA said PACE loans lack sufficient consumer protection. When a borrower with an FHA-backed mortgage is foreclosed upon, the portion of the PACE loan in arrears must be paid off first.
The remaining PACE loan transfers to the new buyer, but the FHA said that increases the likelihood the buyer will pay less, making it more difficult for the agency to meet its obligations.
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"Assessments such as these are potentially dangerous for our Mutual Mortgage Insurance Fund," Housing and Urban Development Secretary Ben Carson said in a statement.
In a statement, Renovate America, the largest PACE lender, said the policy change affects only a small part of its business and that PACE borrowers do not default on their mortgages more frequently than those without PACE loans.
PACE, or Property Assessed Clean Energy, programs, started in 2008, are typically established by local governments, which tie the privately financed loans to purchased homes and allow them to be repaid as line items on property tax bills.
The FHA now joins the Federal Housing Finance Agency, which has barred Fannie Mae and Freddie Mac from purchasing mortgages on homes with PACE loans.
Homeowners who already FHA-backed mortgages can still take out PACE loans, but the FHA said it is concerned about that as well.
"FHA intends to monitor this carefully to determine whether further action is warranted," the agency said in a news release.