Property Assessed Clean Energy (PACE) Loans: What Homebuyers Need to Know

What Are PACE Loans and Why Do They Matter

Property Assessed Clean Energy (PACE) loans are financing programs offered by local governments to help homeowners pay for energy-efficient improvements like solar panels, new windows, or HVAC systems. The loan payments are typically collected through your property tax bill, which creates a unique problem for mortgage lenders. Most PACE loans automatically become first liens on your property, meaning they get paid before your mortgage if you default. This conflicts with the standard mortgage contract, which requires the mortgage to be the first lien. Think of it like having two people claim they're first in line — it creates a legal conflict that Fannie Mae won't accept. Say you installed solar panels through a PACE program and owe $25,000. Even though you took out your mortgage first, the PACE loan jumps ahead in priority. If you default and the house sells for less than what you owe, the PACE loan gets paid first, leaving your mortgage lender with less security.

When PACE Loans Block Fannie Mae Financing

Fannie Mae's rule is straightforward: they will not purchase mortgage loans on properties where a PACE loan has lien priority over the first mortgage. This means if you have a typical PACE loan with first lien status, you cannot get a Fannie Mae-backed mortgage. Your lender will need to verify whether any PACE programs in your area create senior liens. PACE programs vary by state and locality, so what applies in California may be different from Texas or Florida. If you're buying a home that already has a PACE loan with lien priority, you have limited options. You might need to pay off the PACE loan before closing, find a non-Fannie Mae lender, or look for a different property.

PACE Loans That Work With Fannie Mae

Not all PACE loans create problems. If the PACE loan is structured as a subordinate lien (meaning it comes after your mortgage in priority) or as an unsecured loan, Fannie Mae will accept the mortgage under their standard guidelines. Some newer PACE programs have been designed specifically to avoid the lien priority issue. These programs structure the financing so it doesn't interfere with first mortgage liens. You'll still need to include the PACE loan payment in your debt-to-income calculations, just like any other monthly obligation. If your PACE payment is $200 per month, that gets added to your mortgage payment, car loans, and credit card minimums when the lender calculates your qualifying ratios.

Required Disclosures on Your Mortgage Application

When you complete your mortgage application on Form 1003, you must disclose if the property will be subject to a PACE lien that takes priority over the first mortgage. This appears in Section 5a E of the form. Your lender must also indicate in Section L1 if the property is currently subject to a PACE lien with priority over the first mortgage. This disclosure requirement helps ensure everyone understands the lien structure before closing. Failing to disclose a PACE loan can create serious problems later. The lender might discover it during the title search, which could delay or kill your loan approval.

Special Rules for Pre-2010 PACE Loans

Fannie Mae has a grandfather clause for PACE loans originated before July 6, 2010. If you have one of these older PACE loans, different rules apply. For mortgages that Fannie Mae purchased before July 6, 2010, or that were securitized in mortgage-backed securities pools with issue dates on or before July 1, 2010, the normal prohibition against senior PACE liens doesn't apply. This exception recognizes that these arrangements were in place before Fannie Mae clarified their policy. This grandfather provision only helps if you already have an existing Fannie Mae mortgage. It doesn't help new borrowers trying to get financing on properties with old PACE loans.

Refinancing Options When You Have a PACE Loan

If you currently have a Fannie Mae mortgage and want to refinance a property with a PACE loan from before July 6, 2010, you have two main options. The preferred option is paying off the PACE loan as part of your refinance. Your lender must first try to qualify you for either a cash-out or limited cash-out refinance with enough proceeds to eliminate the PACE obligation. This removes the lien priority conflict entirely. For limited cash-out refinances, Fannie Mae waives their normal rule against using proceeds to pay off loans that weren't used to purchase the property. Normally, you can't use a limited cash-out refinance to pay off a home equity loan, but they make an exception for PACE loans.

When You Can't Pay Off the PACE Loan

If you don't have enough equity to pay off the PACE loan through refinancing, you may still qualify for a limited cash-out refinance with the PACE loan remaining in place. This is the fallback option when paying off the PACE loan isn't feasible. In these cases, you don't include the PACE loan balance in your combined loan-to-value (CLTV) ratio calculation. However, you must include the monthly PACE payment in your housing expense and debt-to-income calculations. Say your house is worth $300,000, you owe $240,000 on your mortgage, and you have a $15,000 PACE loan. Your loan-to-value ratio is calculated as 80% ($240,000 ÷ $300,000), not 85%. But your monthly payment calculation includes both the mortgage payment and the PACE payment.

Documentation and Delivery Requirements

Loans where the PACE loan remains in place must be delivered to Fannie Mae with Special Feature Code (SFC) 173. This code alerts Fannie Mae that the loan involves a PACE situation that received special handling. Your lender needs to document that they attempted to qualify you for a payoff option first. They must show that paying off the PACE loan wasn't feasible given your financial situation and the property's value. The underwriter will verify that the PACE loan payment is properly included in your debt-to-income calculations and that all disclosure requirements were met.

Common Problems and Complications

Many borrowers don't realize they have a PACE loan until they try to refinance or sell. PACE assessments can be easy to overlook because they're often rolled into property tax bills rather than appearing as separate loan statements. Title companies sometimes miss PACE liens during their initial search, discovering them only when preparing final documents. This can cause last-minute delays or require restructuring the entire transaction. Some PACE programs allow the assessment to transfer to new owners, while others require payoff at sale. Make sure you understand your specific program's rules before listing your property. Desktop Underwriter (DU) may give an "Ineligible" recommendation for limited cash-out refinances when it appears you're receiving more than the normal cash-back limits due to PACE loan payoffs. Your lender can still deliver the loan with this recommendation if it meets all other requirements, including those in [[A2-2-04]].

References

For the official guidelines, see B5-3.4-01: Property Assessed Clean Energy Loans in the Fannie Mae Selling Guide.