HERO or PACE Lien Getting in the Way of a Home Refinance?
Financing a Home Purchase With a HERO Lien or PACE Lien
If you found this article during an online search, it’s very likely you, or the property you want to buy (or refinance), is in some sort of a financial pickle because of a HERO lien or PACE lien. Before we go any further, is important to keep in mind that the HERO and PACE programs were enacted with the best of intentions. However, less than stellar execution for both programs has resulted in headaches for many California homeowners when selling a house, or financing a home purchase with a HERO lien or PACE lien attached to the property.
The HERO loan program and PACE loan program are still very popular with Southern Californians. Unfortunately, sometimes they can cause problems when homeowners try to sell (or refinance) their house or finance a home purchase with a HERO lien or PACE lien against them. In fact, failure to find and take advantage of the right loan program can hold up a sale or cancel the transaction entirely.
The purpose of this article is to introduce potential issues that can arise with property (and for property owners) under the PACE loan program or HERO financing program. To delve even further in depth on this topic, we welcome you to visit and read through the following pages, which discuss certain facets of both programs in more detail:
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To get started here, let’s take a look at these two programs, including how they’re used and how you can overcome lien issues currently creating problems for many California homeowners….
The HERO Program in California
The HERO program in California dates back to 2010. HERO is the acronym for the “Home Energy Retrofit Opportunity.” This program was developed through a partnership between Renovate America and the Western Riverside Council of Governments (WRCOG), which is a public agency representing the 18 communities within Riverside County. Presently, 85% of all residents statewide are eligible for HERO. The HERO program in California is just one component of the Property Assessed Clean Energy effort, or PACE.
The PACE Program in California
The PACE program in California was established back in 2001. Since then, it has been copied in various forms by more than 30 states nationwide. The PACE program in California allows property owners to install energy efficient improvements in an existing home with very little (or even zero) upfront costs associated with the funds provided. If the improvement is listed on the PACE approved list, funds can be used to pay for the materials and labor required to complete the energy efficient improvement.
What Improvements Qualify for the PACE Loan Program?
In order to quality for the PACE loan program, projects must be permanently attached to the property, and they must be able to be conveyed to a new property owner. The improvement must be installed with the purpose of reducing on-site electrical, gas or water usage. For example, common improvements that can be financed up to 100% of the cost include heating, ventilation and air conditioning (HVAC) replacements, new solar panels, and even low-flow toilets or water saving plumbing shower and sink faucets.
Specifically, water conservation improvements qualify for the PACE loan program so long as they can be shown to reduce water usage compared to a standard fixture. If there are any questions about what types of improvements can be made, we welcome you to contact us or any local PACE loan program lender. Please keep in mind that it is very possible only approved PACE contractors can be used to perform your home renovation projects under this program.
HERO Program Financing Information
HERO is one of the approved programs under the PACE umbrella. It is also the most common here in San Diego County and throughout Southern California. Getting approved for HERO program financing is relatively easy. First, the property must be located in a designated, drought-impacted area. If there is an existing mortgage on the property, there cannot be more than one mortgage payment listed on a credit report as being more than 30 days past the due date over the last 12 months. More than one late payment in the past year means a homeowner will not qualify for HERO program financing.
Also, property taxes must be current on the property, and there can be no more than one late property tax payment over the past 36 months. Other liens, such as tax liens, support payment liens and mechanics liens must be paid off and recorded as paid in full. Additionally, any such liens must be officially removed in order to qualify.
There are no upfront fees for a HERO program financing loan. The term can be up to 20 years with an interest rate as high as 11.00%. Once the HERO application is approved, an applicant can select approved HERO products, as well as a HERO approved contractor. The last step involves signing the financial documents and disclosures. You can choose from many different products as long as they are HERO eligible. However, many homeowners invest in an energy audit to identify potential improvements providing the greatest benefits for the lowest costs.
A HERO program financing loan is paid back with an assessment on a homeowner’s property tax bill. If homeowners’ impound for taxes, then it’s a good idea to contact the servicer on the mortgage and let them know there will be additional funds needed to pay for the HERO program once taxes become due. Otherwise, a larger lump sum payment will need to be made by the homeowner out-of-pocket.
It is very important to understand that once you take money from your HERO loan for your property improvements, it then becomes a HERO lien. The HERO lien is recorded on your financial record as a so-called “superior” lien. Therein lies the seemingly subtle, yet potentially serious issue with HERO program financing: The position and character of the lien itself.
Types of Property Liens: Recorded Liens on Property
Recorded liens on property are evidence of a legal interest in the property. Recorded liens on property can come with a different status. Liens are filed by date, which means an earlier lien has a higher priority than a later one. For example, let’s say someone buys and finances a home with a mortgage. That mortgage is recorded as a first lien. Later, the homeowner decides to take out a second mortgage to pay off some bills and finance a college education. The second mortgage takes a secondary, or “junior” lien status because it came later.
Now, both liens are in fact a home loan. However, because the first mortgage was recorded prior to the second, when the home is sold the first lien will be paid off before the second lien. This is important to the first lien lender because it ensures said lender will get paid off first in the instance there isn’t enough equity in the property to satisfy both liens. This applies whether the home is sold or foreclosed.
To put this in a tangible “dollars and cents” context, let’s say a homeowner lists a home for sale at $250,000, and there is a first lien of $225,000 and a second lien of $50,000 for a total amount due to both lenders of $275,000. In this scenario, the first mortgage would be paid off with net proceeds from the sale and after deducting required closing costs. Let’s say closing costs are $5,000. That leaves $245,000 available to satisfy existing liens. The first lien balance of $225,000 is settled, which leaves $20,000 available to pay the second lien of $50,000. However, the seller will then need to pay the $30,000 out-of-pocket to the second lender in order to transfer the property to the home’s new buyers with a clean title.
The second lien lender will want to get paid, of course. Therefore, unless the lender agrees to accept a lower settlement amount, the current owners must come up with the $30,000 on their own. If they do not have that amount of money and the lender does not agree to a lower amount, the transaction will most likely be cancelled. This means the sellers will not be able to sell the property until and unless property values increase to the point it will take care of all liens. This is the reason junior liens carry higher interest rates, which results from the inherent risk involved in being second in line.
It is also important to understand that the first lien lender can foreclose on a property even with an existing second lien. In this same scenario, it is possible the first mortgage lender could take ownership of the property, sell it and leave the existing second lien lender out in the cold. As you can see, recorded liens on property can get quite tricky for homeowners, as well as for lenders that offer a homeowner financing.
H2: Types of Property Liens: Superior Lien
The highest priority liens are called “superior liens.” These must be paid off prior to any other type of lien. This includes a first mortgage lien, regardless of what date the superior lien was filed in relation to the first mortgage lien. Basically, a superior lien cuts to the front of the line in in place of all other recorded liens on property.
What types of liens are granted superior status regardless of when they’re filed? Well, federal and state income tax liens, property taxes, homeowners association or condo dues, as well as any liens filed by a contractor for work performed on the property (called a “mechanics lien”). Liens filed due to delinquent alimony or child support are also considered superior.
It is important to understand that a HERO loan is listed as a superior lien, and it is assessed as such on the homeowner’s property tax bill. In this context, any existing liens (like mortgages) take a backseat to the HERO lien regardless of their filing dates. Additionally, any liens placed against the property after the HERO loan is granted will automatically defer to the superior status of a HERO lien.
Potential HERO Financing Program Issues
If you have owned a home with the help of a mortgage loan before, you are most likely familiar with conventional loans. Conventional loans are approved using guidelines established by mortgage giants Fannie Mae and Freddie Mac. They make up the largest market share of all property loans in today’s marketplace. The HERO financing program can cause issues when a homeowner with a superior HERO or PACE lien tries to obtain a conventional loan.
This is because the Federal Housing Finance Agency (FHFA) has declared homeowners’ ineligible for conventional loans during a refinance or a purchase with a HERO or PACE lien on record. Therefore, the property owner must pay this superior lien off first in order for conventional financing to become an option.
However, options do indeed exist even with a HERO lien recorded on the property. Some methods to obtain financing include using a special VA, FHA or USDA loan. These loans can outright purchase, or at least refinance, an existing loan with a HERO or PACE lien attached. The important thing to know is that in order for these special loans to be options, the current appraised loan value (including all mortgages/liens) cannot exceed 125% of the value of the home. A standard residential property appraisal report will be used to verify property value in these cases.
So, say the home in question is listed at $250,000 with an existing first mortgage of $225,000 and an existing PACE lien of $50,000 (this is the example used earlier). With these programs, we can finance up to 125% of the value of the property, or $312,500. This means buyers can buy the home while sellers retire all the existing liens to transfer the property with a clean title report. This is why it is important to keep in mind that accepting the terms of a HERO financing program does not automatically impede mobility depending on certain specifics.
VA Home Loan Programs and HERO
Borrowers who are eligible for VA home loan programs, and who do not wish to put a down payment on a purchase while simultaneously keeping closing costs to a minimum, will find VA home loan programs to be the preferred choice among all available mortgage options.
Eligibility for VA home loan programs is determined by reviewing a copy of a veteran’s Certificate of Eligibility, or COE, which is obtained directly from the VA. Those that are typically eligible are veterans of the Armed Forces discharged other than dishonorably, active duty personnel with at least 181 days of service, and surviving spouses of those previously eligible who died due to a service related injury.
Others who might be eligible for VA home loan programs include those with at least six years of service (either active or veterans), and those with the National Guard or Armed Forces Reserves. VA home loan programs require no down payment, offer competitive interest rates and reduced closing fees. Additionally, VA home loans can be used to finance a single family home, a 2-4 unit property, a condo, or a home in a planned unit development (PUD) as long as the property will be the homeowner’s primary residence.
FHA Loan Programs and HERO
FHA loan programs were first introduced in 1934. They provided some stability and universality in the burgeoning home lending industry. With the introduction of these loans, the Department of Housing and Urban Development introduced low-down payment programs eligible to any creditworthy borrower.
Currently, FHA loan programs are loans of choice for first-time home buyers because of the low down payment requirement and easier qualifying compared to a conventional loan with 5.00% down. However, they are not necessarily limited to people who have never owned a home before. As long as the home being financed will be the primary residence, FHA loan programs can also be used to finance a home with an existing HERO lien or PACE lien attached.
USDA Home Loan Programs and HERO
The United States Department of Agriculture (USDA) also has its own program to finance owner-occupied homes. Just like a VA mortgage, USDA home loan programs require no down payment. Also, and just like with a VA home loan, USDA home loan programs have specific requirements that reduce eligibility where potential borrowers are concerned.
USDA home loan programs state that the property being financed with a USDA loan must be in an approved geographic area. Much like the scope of the agency itself, USDA home loan programs are designed to finance property in rural or semi-rural areas. The USDA keeps an online database telling potential buyers (and USDA approved lenders) whether or not property is in an approved district. You can find this out simply by entering the address of the property.
If the property is indeed located in an approved zone, household income is then measured to determine program eligibility. According to USDA guidelines, household income from those living on the property cannot exceed specific income limits established for the particular county where the property is located. It also should not exceed 115% of the median income for that area.
It is important to understand that specific calculations are required when determining qualifying income for a USDA home loan programs. Because of this, we don’t recommend trying to prequalify on your own. In all our years helping clients obtain USDA loans, we have met many people who didn’t proceed with the mortgage process because they incorrectly assumed they made too much money…. when they actually didn’t once we crunched their numbers for them.
H2: HERO Loan Program and PACE Loan Program Disclaimers
Now that we have discussed limitations and exceptions to HERO loan program and PACE loan program options, we need to share some very important information with you regarding those who may be processing your HERO or PACE loan applications. In order to do so in the proper context, let’s talk about the regulations for a typical loan officer in the state of California.
When a person applying for a mortgage loan in California speaks with a loan officer, he or she is licensed by the state to perform the functions required by a residential mortgage loan officer. This means a loan officer must complete an initial 20 hours of education. The loan officer must also complete testing with a passing grade, as well as pass a minimum number of continuing education hours when required.
However, representatives of a HERO loan program and PACE loan program do not need to undergo loan officer training. Even though HERO and PACE funds are in fact loans (and therefore must be paid back when due), the people taking your HERO application do not have to be licensed loan officers. What is more, in most cases the people taking your application are not licensed for mortgage loans either.
This fact has led to countless issues for California homeowners who accept the terms of HERO and PACE loans without those loans being properly explained to them. This is also where many homeowners can avoid potential problems down the road if they are told of the potential impact of a HERO lien or PACE lien on their records. This isn’t to say that all HERO loans (and HERO loan representatives) are bad. Rather, it’s just that those representatives are not properly trained to responsibly disclose the information you need to make a fully informed decision.
This is why San Diego Purchase Loans wants to make sure our clients understand some very basic, but incredibly important aspects of the HERO loan program, like:
Do homeowners understand the validity or even the definition of a superior lien?
Does the average homeowner know what a junior lien is?
If you do not understand how these terms can affect your financial record, it can lead to some unhappy consequences later when you decide to refinance to a lower rate or sell the home you suddenly find is “underwater” due a lien from your existing PACE loan program indebtedness.
What is more, when a seller lists a home for sale, he or she must also provide a document to prospective buyers stating any known issues with the property. For example, if the backyard deck needs the rails replaced, then it should be a listed item. Along these lines:
Does the hot water heater work properly?
Was there any water damage in the past or any other issue with the property that could affect the value or even halt a sale?
Finally, many homeowners who decide to sell with an existing HERO lien have increased the value of their property due to the energy efficient improvements. When this is the case, the homeowner must also disclose the existence of a HERO or PACE lien, the same as with any other potential defect.
Let San Diego Purchase Loans Help With PACE and HERO
We at San Diego Purchase Loans want to be crystal clear here: The HERO and PACE programs do successfully fulfill their missions, as they help conserve energy and water. What is more, they do so with very little if any upfront cash from property owners. In general and in these regards, both are very good programs in the way there are intended to be.
However, the nature of the debt incurred via these programs requires buyers (or those who are refinancing) to be informed about the implications of such liens on their financial records. If not addressed ahead of time, a lack of education and information will undoubtedly cause problems in the long run. This is especially true if someone does not find the proper financing program to work around HERO and PACE liens currently in place on a property.
This also applies to buyers familiar with only conventional loans, who can be easily misled into thinking a HERO lien on a property means they can’t get financing at all. In many cases and because of the lien’s presence, these buyers will end up moving on to another property because they haven’t spoken with the right lender. Regardless of your specific situation, we want you to know there are indeed options out there for you. At San Diego Purchase Loans, our job is to help educate you about these options, and then help you choose the one that works best for you. Please contact us today to learn more about how we can help.