Building a green mortgage market

In October 2021, the government published its Heat and Buildings Strategy (Strategy). Decarbonising energy used in buildings forms a key part of the government’s Clean Growth Strategy and underpins the Prime Minister's Ten Point Plan for a Green Industrial Revolution. This requires improvements to the energy efficiency of buildings, changes to the way we heat and cool our buildings and improving the performance of energy-related products.

The Strategy brings together the government's work on energy efficiency and clean heat. It seeks to ensure that the UK has a consistent and coherent approach across different markets, buildings and occupancy types and a credible pathway to achieving Net Zero targets.

In this column, I consider the key aspects of the Strategy for the mortgage market and some of the key questions that lenders should consider in preparing for what comes next.

For information on the Strategy, see Legal update, Government publishes Heat and Buildings package including long-awaited Strategy.

Key aspects of Strategy for the mortgage market

There are several aspects of the Strategy that will be of particular interest to the mortgage market:

• Minimum energy efficiency standards for property. The Strategy sets out the government's ambition to build on its 2020 consultation on improving the energy performance of privately rented homes using minimum standards to ensure the UK housing stock is on track to meet EPC band C by 2035 where practical.
• Disclosure requirements and targets for lenders. Earlier in the year, the government consulted on improving home energy performance through lenders. This included proposals to introduce mandatory disclosure requirements for mortgage lenders on the energy performance of homes on which they lend, and on setting voluntary targets to improve the energy performance of their portfolios to an average of EPC band C by 2030. The consultation proposed making these targets mandatory if insufficient progress is being made. In the government's view, this would:
  encourage significant product innovation and new partnerships and drive the development of a green home finance market to support homeowners to make energy efficient improvements.
  
  These measures remain under consideration.
• Developing supply of green finance. Different types of buildings – with different users, owners and heating needs – will require different types of financial support to decarbonise. The government wants to challenge industry to innovate and improve the affordability of energy efficient technology and see developing new financing models for consumers as one mechanism to achieve this, with mortgage lenders and other organisations having a key role to play. The Strategy recognises that there is investor interest in green finance products globally, but this has yet to be converted into established financial products in the UK.
  
  Building on the outputs and learnings from the Green Home Finance Innovation Fund competition, the Strategy announces the launch of a further programme to provide grant funding to stimulate more innovation in the UK green home finance market. This may include support for UK retail lenders to design, develop and pilot a range of finance propositions that encourage domestic installation of energy efficient measures and low-carbon heat. This funding programme will formally launch by spring 2022.
• The role of mortgage lenders as a catalyst for change. For mortgaged properties, the government sees lenders as uniquely placed to influence homeowners, landlords and businesses to undertake energy efficient property upgrades at key trigger points in the mortgage lifecycle such as the point of purchase, renovation or re-mortgage.
• Link between energy efficient home improvements and risk of default. The Strategy notes emerging evidence suggesting a link between investments in energy efficiency and low-carbon technology on the one hand and property values and a lower risk of default on the other.

Impact of Strategy on the mortgage market

Understandably, when the Strategy was launched it was the risk of "energy-efficiency mortgage prisoners" and potential financial exclusion that dominated the headlines across the mainstream and trade press.

It is clear from the Strategy that there are considerable hurdles to overcome particularly to boost the financing of energy efficient retrofits in the UK and that there is no one-size-fits-all solution to the decarbonisation of buildings.

In particular, there are a number of risks that financial institutions would need to consider and manage if some of the measures where introduced, including ensuring that both:

• Borrowers are not "trapped" in older, less energy efficient homes due to changes in product availability.
• Conduct risk is not inadvertently created through changes to pricing practices between products linked to energy efficient home improvement and those that are not.

However, these risks and challenges are not insurmountable. The Strategy provides a starting point, but what is clear is a more complete and co-ordinated plan is needed between government, regulators and industry to achieve the ultimate goal of upgrading all UK property to an EPC rating of C.

We are already seeing significant growth in supply of green mortgage products across the residential and buy-to-let mortgage market. Yet, although homeowners in the UK who are looking for a green mortgage have more options than ever before, to-date one of the key challenges to growth and development has been consumer demand.

One of the ways the Strategy seeks to address this is through a combination of government support for advice to homeowners on how they can improve their building's energy efficiency (for example, through the Simple Energy Advice online platform) and introduction of minimum property standards.
In addition to the measures set out in the Strategy, there are other potential steps that could be considered to help accelerate green innovation in the mortgage market (as recognised by the Climate Financial Risk Forum). These include:

• Reflecting actual household energy costs (one of the largest unavoidable outgoings every mortgage borrower incurs) differently in mortgage applications, in which case lenders may be able to justify higher lending to low energy cost properties.
• Creating a high-level framework of market standards and guidelines for a green mortgage market.
• Freeing up capital that banks can reinvest in additional green mortgages and loans.

In summary

It is clear that the government considers that mortgage lenders have a key role to play in its strategy to decarbonise buildings. It is important that the industry to continue to engage with the government on the Strategy and its implementation to ensure that introduction of legislative, regulatory and policy standards align with product availability and market conditions and to mitigate some of the risks outlined above.

I expect the development of financial products to support improvements to the energy efficiency of buildings to continue to be a key trend in the mortgage market over the short to medium term.

This article was first published by Practical Law UK