On May 1, 2023, the Consumer Financial Protection Bureau (“CFPB” or “Bureau”) issued a proposed rule that would require companies offering Property Assessed Clean Energy (“PACE”) loans to consider a consumer’s ability to repay as well as provide consumer disclosures on the cost of credit similar to those used in connection with residential mortgage loans.1 If the Bureau adopts its proposed rule, PACE loans may be subject to regulation akin to a traditional closed-end residential mortgage loan under the federal Truth in Lending Act (“TILA”) and its implementing Regulation Z. This proposed rule fulfills Congress’s mandate under the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) directing the Bureau to issue rules applying TILA’s ability to repay and civil liability provisions to PACE financing. The proposed rule follows the Bureau’s initial advance notice of proposed rulemaking issued over four years ago.2
PACE loans are an alternative for financing energy-efficient home improvements or upgrades in preparation for natural disasters. A typical PACE financing enables borrowers to finance improvements to their home through a tax assessment on their property. Borrowers typically repay their PACE loan through special property tax assessments, and PACE loans are generally secured by a property tax lien that takes priority over both existing and future mortgages on the borrower’s real property. Because PACE financing leverages state and local property tax systems to provide financing and obtain repayment, PACE programs have typically been created through state and local legislation that adopts and enables PACE programs. While states and municipalities are typically the parties that establish and authorize PACE loan programs, the loans may be marketed and administered through home improvement contractors and private companies that contract with government agencies.
PACE programs enable consumers to access financing for clean energy improvements, particularly if consumers have a limited or poor credit history and may be unable to qualify for other forms of home improvement financing, or do not have sufficient equity in their home to finance the improvements through a home equity line of credit. Residential PACE financing has grown into a significant market. The Bureau’s notice of proposed rulemaking reported that, as of December 31, 2021, PACE programs had financed over $7.7 billion in home improvements. At the same time, the growth of the PACE financing industry has also brought regulatory scrutiny. Much of this scrutiny relates not to the nature of PACE financing itself, but rather to home improvement contractor and salesperson sales tactics and the potential for unfair, deceptive, or abusive practices in the marketing and advertising of PACE loans,3 although the CFPB acknowledged that some PACE programs have also implemented consumer protection controls to oversee and monitor private companies involved in originating PACE financing under a contract with a government entity’s program. A CFPB report claimed that PACE loans on average involved higher interest rates than traditional loan products, which, according to the CFPB, resulted in potential negative credit consequences to borrowers.4 Finally, the Federal Housing Finance Agency has expressed concerns about the effect of a super-priority PACE lien on the value of a lender’s security interest from the perspective of institution safety and soundness.5
Currently, Regulation Z excludes a “tax lien” or a “tax assessment” from the definition of “credit.”6 The consequence of excluding “tax assessments” and “tax liens” from the definition of “credit” for purposes of TILA and Regulation Z is that PACE loans are not subject to regulation under TILA, which only applies to transactions that constitute “credit” (as defined by TILA and Regulation Z). The proposed rule would amend Regulation Z to impose a number of consumer protection requirements on PACE loans. Most significantly, the new rule would classify PACE financing as a form of “credit” for TILA purposes by clarifying that only involuntary tax assessments are excluded from the definition of “credit.” Because voluntary tax assessments, such as the type involved in PACE financing, would no longer be categorically excluded from coverage under TILA and Regulation Z, the proposed rule would subject PACE financing to similar regulatory treatment as closed-end residential mortgage loans for purposes of TILA and Regulation Z, including the mortgage ability-to-repay (“ATR”) rule and civil liability provisions. The ATR rule requires originators of closed-end, dwelling-secured credit to consider and verify the borrower’s ability to repay before consummation. The preamble to the Bureau’s proposed rule cites concerns raised by consumer protection advocates regarding whether PACE companies give sufficient consideration to borrowers’ ability to repay a PACE loan, especially given the reliance of the PACE industry on originating loans in the point-of-sale context. The Regulation Z mortgage ATR requirement currently involves analysis and verification of factors including a borrower’s income, monthly payments for the transaction, existing debt obligations, and credit history. The proposed rule would require a PACE provider to consider the same factors, plus any monthly payments the borrower would have to pay into any escrow account as a result of the PACE transaction. The proposed rule would also categorically exclude PACE financing from eligibility for the presumption of compliance with the ATR rule that is available for mortgage loans that satisfy the standard for a “qualified mortgage.” The CFPB chose not to adopt a more flexible ability-to-repay standard, such as the standard for credit cards under the CARD Act rules. The CARD Act ATR standard requires consideration (but not verification) of the consumer’s ability to make required minimum payments based on the consumer’s income or assets and debt obligations.7
Importantly, the proposed rule extends the ATR requirement to any PACE company that is “substantially” involved in making the credit decision on the borrower’s PACE loan. According to the Bureau, a PACE company would be “substantially involved” in making the credit decision if it (i) makes the credit decision, (ii) makes a recommendation as to whether to extend credit, or (iii) applies criteria used in making the credit decision. On the other hand, merely soliciting applications, collecting application information, or performing administrative tasks would not constitute “substantial involvement” in the credit decision for purposes of the proposed rule. The Bureau explained that this provision is intended to apply the ATR requirement to the private companies that typically administer a PACE program on behalf of a state or local government, but it would not apply to home improvement contractors who do not administer a PACE program. The Bureau’s extension of the ATR requirement to PACE companies that are “substantially involved” in the credit decision could be intended to permit consumer remedies for violations of the ATR requirement. The Bureau’s proposed rule acknowledges that TILA provides that any state, state agency, or “political subdivision thereof” is immune from civil or criminal liability under TILA.8 Thus, consumers would be unable to obtain remedies from a state agency or municipality that is the creditor on a PACE financing and would effectively have no remedy for violations of the ATR requirement if the scope of the proposed rule were limited to the ultimate PACE creditor.
Furthermore, the proposed rule would require a PACE provider to issue a Loan Estimate and a Closing Disclosure to borrowers, albeit with some modifications to account for differences between PACE loans and traditional residential mortgage loans. The Bureau issued model forms for the disclosures, which are similar to those issued for residential mortgage loans and include a detailed statement of loan terms and projected payments. The model Loan Estimate and Closing Disclosure forms for PACE transactions would be added to Appendix H of Regulation Z. Classifying PACE financing as “credit” for purposes of TILA and Regulation Z would also subject PACE financing to other TILA and Regulation Z requirements imposed on closed-end dwelling-secured loans, including the right to rescind the transaction and certain substantive protections for high-cost and higher-priced mortgage loans, with the exception of the mandatory escrow account requirement for “higher-priced” mortgage loans. In addition, home improvement contractors and other persons involved in PACE financing or performing customer acquisition may be subject to the CFPB loan originator compensation rule, which prohibits a mortgage originator from compensating persons performing loan originator activities (such as taking applications, assisting customers in applying for financing, or negotiating terms of credit) based on any term of the transaction.
Companies involved in PACE financing should carefully review the proposed rule and consider whether to submit comments to the Bureau. Comments on the Bureau’s proposed rule are due by July 26, 2023.
2 An earlier Mayer Brown Legal Update summarizes the Advance Notice of Proposed Rulemaking.
3 The Federal Trade Commission and the California Attorney General recently issued a proposed consent order against a company offering PACE financing, alleging that the company’s dealers engaged in high-pressure sales tactics and misrepresented the nature of PACE loan terms.
5 An earlier Mayer Brown Legal Update summarizes the FHFA Request for Input on the impact of PACE programs on loans financed by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.