I’m sure most of you are familiar with The Beatles' song, “Here Comes The Sun,” or Soundgarden’s “Black Hole Sun.” I’m hoping you are singing one of them to yourself now.
Well, this blog post is also about the sun, but definitely not as cool. We are here to discuss solar panels and their effect on home buying and refinancing.
Most lenders insist that their mortgage debt is in the first lien or “senior” lien position on the title of the property. If any of the debt on the property went into default, they would be the first to get paid. There are lenders who provide subordinate financing, or second, third, or fourth lien debt, that will charge higher rates, as the lien position increases. In that same default scenario, they get paid only after the first lien position lender gets paid. This is applicable to this discussion because solar panel equipment acts as collateral for the debt used to purchase/lease the solar panels that are attached to the house and the owner of the solar panel equipment files a Uniform Commercial Code (UCC) filing with the county, similar to a mortgage or deed of trust, that basically states that they have an ownership interest in the panels that are attached to the house until the debt is paid off. Unless there is no mortgage debt on the property, the UCC filing will be in a subordinate lien position (with the exception of a defaulted PACE, HERO, or ELTAP loan, which will be discussed later) and will need to either be subordinated (they must agree to temporarily step aside and allow a new mortgage to be secured in first lien position and then move back into second lien position), or paid off before the new mortgage can be filed against the property. Ok, so what! Can’t you just file for subordination? Well, it is a little trickier than that, because there are several ways to finance the solar panels and there are nuances with each. First off - if you are thinking about either putting solar panels on your home or buying a home with solar panels, make sure you ask if the panels are secured by any of the following loans because if they are, they will need to be paid in full at or before you can complete a refinance or purchase transaction with mortgage debt (info on each type of loan under the hyperlinks): PACE (Property Assessed Clean Energy) HERO (Home Energy Renovation Opportunity) ELTAP (Energy Loan Tax Assessment Program) The reason Fannie Mae and Freddie Mac (the main liquidity providers of mortgage debt) will not provide financing on homes with these unpaid loans on them, is because these loans have the ability to move to first lien position, ahead of the mortgage that was previously in first lien position if the solar debt goes into default. This is similar to unpaid property taxes, which explains why lenders want you to escrow taxes. Lenders don’t want to ever be at risk of a lien that supersedes their lien. With escrows, the lender knows the taxes are being paid and there is less risk of them being knocked out of first lien position due to non-payment of those taxes. See my blog on escrowing taxes and insurance here. Also, consider the fact that if you escrow and the property tax bill comes in higher than expected, where you were not paying enough on a monthly basis to cover the total amount due, the lender will pay the deficit for you, so they are not at risk of the defaulted tax liability pushing them out of first lien position. You will then have an increased monthly payment until you have paid back the deficit. I should note that Fannie and Freddie will allow you to include the payoff of PACE, HERO, and ELTAP loans in the mortgage and still consider the transaction a non-cash-out transaction. Typically, when any debt other than the mortgage or in some instances, second mortgages, are being paid off, the loan is considered a cash-out refinance that will have a higher rate than a non-cash-out refinance. If paid off, the UCC filing would be terminated at closing and there would no longer be any risk to the lender of a superseding solar lien. So you don’t have a PACE, HERO, or ELTAP loan… There are a few other ways solar panels can be financed: PPA (Power Purchase Agreement) Lease Solar Panel Financing Why it is important to know how the panels are financed, is because lenders look at each one slightly different from a qualification standpoint. These are different from the PACE, HERO, and ELTAP loans in that these loans cannot take over the first lien position in a default scenario (as long as the proper verbiage exists in the agreements). All of these financing types will have a UCC filing recorded, which will need to be temporarily terminated by the solar company and then refiled after the new mortgage/deed of trust is recorded in the first lien position. The lender will need to file a request for subordination with the solar company to get this done. If you are buying a home from someone that has one of these financing types in place, you will still need to file for subordination, but there will also be a concurrent transfer of the existing terms of the PPA / lease/financing. I can say from experience that this is never an easy task, it comes with a price tag of about $250-$500 and it is typically a communication nightmare dealing with solar companies. With PPAs, the owner of the equipment pulls in power from the panels and distributes it to the homeowner (at a cost), but also distributes additional power generated by the panels elsewhere for a profit. The homeowner is not paying to finance the panels, so they don’t need to make payments toward the equipment, they make payments to buy power (at a lower price than regular electricity). Because lenders do not consider utility costs (electricity) in the debt-to-income ratio when they qualify the borrower’s ability to repay, the panels do not have any associated debt liability from an income qualification standpoint. With leased panels or panels that are financed through some other facility, the lender will consider the monthly lease or finance payment in the borrower’s overall debt-to-income ratio, which can affect the approval of the loan. Make sure you let your loan officer know there are solar panels right up front, even if you are looking for a pre-approval to purchase, because the approval could blow up later, with the late introduction of additional monthly debt. Also, consider the fact that the subordination / UCC termination and transfer of liability (if you are purchasing a property with solar panels) can take several weeks and even a month in some instances to get the proper paperwork filed. With financed panels, i.e, the panels are borrower owned with debt on them, an important fact must be identified early in the loan process. Was the solar panel debt collateralized by the property’s value, which included the existence of the solar panels, i.e. the property would be valued lower if the panels were removed? If so, then the panels’ debt must be considered in the combined loan-to-value (CLTV) calculation, which is the first mortgage balance + solar debt balance divided by the value of the property. In this scenario, there will be an increase to the rate, because the loan to value (LTV), i.e. the mortgage balance divided by the value of the property, does not equal the CLTV, and lenders consider this a risk add-on. As an alternative, if the panels were not considered as part of the property’s value, i.e. the solar debt was collateralized solely by the value of the equipment, then the solar debt is not considered in the CLTV and there will not be an increase to the rate. This is not applicable to leases, PPA, HERO, or ELTAP loans. If there is a PPA or lease agreement, the lender will require a copy of the agreement to ensure that the proper verbiage exists that states: that in the event of a foreclosure or transfer of title, the owner of the panels (not the homeowner) will be responsible for the termination of the PPA/lease or enter into a new PPA/lease with the new homeowner. This protects the mortgage lender from the UCC filing, also applicable to these loans, from moving ahead of them into the first lien position. One other thing to note. Just because the house has solar panels, you need to be aware that many lenders will require that that home is also connected to the standard electric grid, even if you are not sourcing power from it. If you are buying a home where the solar panels are owned outright, you don’t have any real issues to deal with, other than establishing an account and connectivity with the company that is facilitating the transfer of power.