The energy crisis has made energy expenditure one of the most important affordability assessment criteria for residential mortgages.
As homeowners need more and more income to cover their energy bills, they are less able to afford their mortgage payments.
It’s the UK’s most inefficient properties that are most impacted.
In fact, our recent white paper shows that a home with an EPC G cost on average £6,044 to power in 2022 (the height of the energy crisis), a staggering eight times more than an EPC A rated home at just £733.
Further, studies have shown that residential mortgages against energy inefficient properties are significantly more likely to be in arrears.
A 2020 paper by Bank of England researchers, for instance, found that residential mortgages against energy-efficient properties (EPC Bands A-C) are around 18% less likely to be in arrears than those against energy-inefficient properties (EPC Bands E-G).
Of course, this has a huge risk management implication for mortgage lenders – as does the fact that energy inefficient homes are likely to lose value over time. That’s why energy efficiency should be included in every affordability assessment.
To do that, lenders need access to accurate energy performance data to ensure accurate household expenditure calculations.
💡 Did you know: unreliable affordability assessments aren’t the only risk blind spot being caused by incomplete, inaccurate, and out-of-date EPC data…
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How bringing energy performance data into affordability assessments reduces risk
We’ve seen that the more inefficient a property the higher the energy bills and the more likely the borrower is to fall into arrears on their mortgage – meaning a much more risky investment for a lender.
How much does including energy performance data on the house during affordability assessment actually reduce that risk? Let’s take a closer look.
In 2015 the UK Green Building Council and UCL Energy Institute released a study titled ‘The role of energy bill modelling in mortgage affordability calculations’ – the results of which also went on to inform both a 2016 research paper for Procedia Engineering and the LENDERs green mortgages project, funded by Innovate UK.
The study sought to quantify the reduction in affordability assessment risk if mortgage lenders were to use energy performance data to determine actual expected energy spend, instead of relying on generic ONS estimates.
After analysing 40,000 UK homes the researchers found that:
- The standard ‘mortgage lender model’ of using ONS data to predict energy bills had a predictive power of just 18%
- Using freely available EPC data for a view of actual energy use in the home being purchased had a predictive power of 38% – twice as accurate as the current norm
- For an example 3 bedroom house, this translated to a difference in household expenditure of between £11,500 to £45,000 over a 25 year mortgage period – a significant additional cost to factor into affordability
- Aggregated over an entire mortgage portfolio for a lender, this additional cost could “quickly run into many millions or even billions of pounds” – especially given it’s also highly likely that new policy will be introduced during the lifetime of the mortgage to mandate that homeowners improve the energy efficiency of their home, requiring further income.
So, it’s clear that introducing energy performance data for the building does significantly increase the accuracy of affordability assessments for mortgages and reduce risk for the lender.
“If lenders could be persuaded to start using a more detailed model to calculate energy costs, they would therefore have an opportunity to significantly reduce risk in their lending.”
– Richard Griffiths, UK-GBC and Ian Hamilton & Gesche Huebner, UCL Energy Institute
However, we can also see from this data that EPCs are not particularly accurate – using EPC data only achieved a correct prediction 38% of the time. The researchers point this out in their conclusion, highlighting that EPCs are ‘not as good an indicator of likely energy costs as they could be’ due to the ‘shortcomings of the EPC methodology’.
Public criticism at the time that the LENDER report was released further emphasised this flaw too:
If mortgage lenders had access to truly accurate data on the energy performance of UK houses, the accuracy of affordability assessments would be drastically improved.
How are mortgage lenders currently modelling energy bills into affordability?
Since the FCA’s Mortgage Market Review (MMR) came into force in 2014 it has been mandatory for mortgage lenders to include a basic understanding of household expenditure in their affordability assessment, including energy bills.
So in theory lenders are already including energy as a factor in affordability.
However, as we’ve mentioned, the reality is that most use basic ONS insights on the average energy cost per person for this, creating a very broad estimate. That estimate does not take into account the energy performance of the house they’re planning to buy which, as we’ve seen, varies significantly and has huge implications for energy bill expenditure.
A handful of climate-leading lenders have started to factor actual energy performance of the building into their affordability assessment (like Leeds Building Society, for example). But they use only freely available EPC data which is well-known to be patchy, unreliable, and out-of-date – problems that we’ve seen in action through the results of the UK GBC study discussed earlier.
So, how can mortgage lenders access energy performance data for UK homes that is actually reliable enough to ensure accurate affordability assessments and reduced risk?
Mortgage lenders can access the most accurate energy performance data with Kamma
At Kamma we’ve developed the most accurate view of the energy and environmental performance of UK housing so that mortgage lenders can have confidence in affordability assessments.
Our dataset combines EPCs with data from a range of additional sources, which is then checked, corrected, and calibrated. Where there is missing data (because only 49% of UK homes actually have an EPC in the first place) our intelligent predictive modelling fills the gaps to an incredibly high level of accuracy.
That’s why lenders like Octopus Real Estate are trusting our data to help them drive the uptake of their green mortgage options.
To explore how this could reduce risk and increase revenue for your company, book a consultation ➡️
