Mortgage lenders have the power to unlock a highly impactful and profitable virtuous circle of green lending for home retrofit.
If lenders create green mortgages and retrofit loans that truly incentivise borrowers to improve the energy efficiency of their homes they can help to drive retrofit and decarbonise the UK’s carbon-intensive housing stock.
In doing so, they will also create a supply of green assets which can be issued as green residential mortgage-backed securities (RMBS) and sold on to investors as low-risk and high-reward – building the sustainable investment market and delivering financial returns for the lender.
It’s a win-win scenario for all involved: lenders, investors, homeowners, and the planet.
But, so far, this virtuous circle has been held back by the reliance on inaccurate EPC data as the primary source for understanding the energy efficiency of UK homes.
The virtuous circle of green lending for retrofit
Let’s take a look at each part of the virtuous circle of green lending for retrofit in closer detail.
1. Mortgage lenders offer retrofit loans
Mortgage lenders have the potential to play a crucial role in driving the decarbonisation of UK housing, having a close relationship with homeowners when buying and selling.
A valid EPC is necessary when selling a home which brings an awareness of current energy performance, making it the perfect time to engage homeowners in a conversation about retrofit. Plus, many homeowners already have plans for renovations and improvements which retrofit could slot into.
More importantly, lenders also have the ability to overcome the top barrier to home retrofitting: the upfront costs.
So far, lender financing has focused on green mortgages which reward homes that are already energy efficient, typically only EPC A or B are eligible.
There are very few homes in the UK that are an EPC A or B, and the vast majority of those that are are new build homes that have been designed to be net zero ready.
This means that green mortgages only reward already low carbon homes, rather than supporting decarbonisation through retrofit.
On the other hand, retrofit loans with preferential interest rates (like Nationwide’s 0% interest Green Additional Borrowing Mortgage, for example) can enable homeowners to cover the costs of retrofit improvements – which will then be recouped via reduced energy bills once the improvements are in place (as well as an increased property value in the long-term).
2. Homeowners retrofit their homes to be energy efficient
Once the barrier of upfront costs for the homeowner has been lifted through a retrofit loan, retrofit becomes a no-brainer.
They’re left with the promise of reduced energy bills, improved comfort, increased property value, and lower environmental impact to boot.
This increases the uptake of home retrofit, driving forward the decarbonisation of UK homes towards the government’s target of all homes being an EPC C or above by 2035 and vastly reducing the UK’s carbon emissions by around 13 million tonnes per year.
We calculated that upgrading all homes in England and Wales to an EPC C or above would cost around £48.3 billion in retrofit improvements – which would also support up to 580,000 jobs related to retrofitting (PwC, Green Jobs Barometer).
Lenders can plug this financing gap through green mortgages.
3. Mortgage lenders use the assets to issue green RMBS
The mortgage lender now has a portfolio full of mortgages on houses that are energy efficient, and therefore classify as green assets.
They can securitise the assets and issue a green residential mortgage-backed security (RMBS) – a type of bond which is backed by a set of sustainable assets – at a higher price point than a standard RMBS.
4. Investors invest in the green RMBS
Sustainable investments are lower risk investments:
- Credit risk. Energy inefficient homes may struggle to hold their asset value in future due to price premiums being placed on energy efficient properties – which is already happening in the housing market.
- Regulatory risk. The Climate Change Committee has been clear that 89% of homes have to be EPC A-C if we are to meet net zero targets. Given that, at some point legislation will target the housing sector with force, pushing lenders to adhere to a minimum EPC C standard and making EPC D-G homes high risk assets.
In many cases, sustainable investments are now also seeing higher returns.
Plus, some investors simply want to support social and environmental projects to contribute towards a more sustainable future.
So, investors seek out green investments.
This investor demand is the reason that the mortgage lender can confidently issue their green RMBS at a higher price – because investors are willing to invest at that price for genuinely green opportunities.
5. The green lending cycle continues
The mortgage lender receives income through investment in their green RMBS, potentially even at a higher rate of return than non-green RMBS because of the investors’ own needs for risk management.
This income frees up capital for further lending.
Here’s an illustrative example of how that could work.
£20.3 billion was invested in RMBS in the UK in 2023.
If 15% of that current RMBS market were classified as green (the amount of homes currently EPC A-B) that would be £3.045 million in green RMBS annually. That number could also be higher if they successfully achieved a green premium.
This gives lenders the incentive to support more homeowners to retrofit their homes – using this additional capital to offer green retrofit loans or incentives such as cashback on a green mortgage.
Those incentives mean that homeowners can overcome the upfront costs barrier to retrofit, upgrading their homes.
That means more homes in the mortgage book that qualify as green assets for investment.
And so, the cycle continues.
“A favourable market, with investors paying a premium for better performing sustainable assets, incentivises mortgage lenders to offer green RMBS, thereby increasing lending and lowering interest rates on energy efficient homes.”
Orla Shields, Co-founder and CEO of Kamma
How better property emissions data can unlock the virtuous circle
So far, despite the attractiveness of the virtuous circle of green lending to mortgage lenders, investors, and homeowners alike, there has been little uptake of green mortgages – making up just 0.4% of total mortgage lending.
Similarly, there has also been little uptake of green RMBS by investors.
Whilst green bonds on the whole are growing quickly, the same isn’t true of green securitisations.
In fact, only one lender has so far issued a green securitisation and it failed to achieve a green pricing premium: Kensington Finsbury Square’s green securitisation based on EPC A and B rated homes in the mortgage book.
In our experience, the business case for investing in green RMBS at a higher price point simply isn’t yet strong enough for investors.
However, we are seeing that investors are starting to understand the legislative risks associated with high carbon, energy inefficient property assets.
At Kamma, we recently worked with one issuer who missed out on £50 million of investment because they didn’t have the right ESG data to provide to the potential investor.
Investors and asset managers are, of course, financial institutions themselves – they have their own transition plans, net zero targets, and climate-related financial disclosures to worry about, so they need reliable emissions data for any investments they make. Plus, the Bank of England now mandates the reporting of EPCs on property-related issuances, so investors are starting to expect this data from issuers.
Because of these factors, investors are starting to see ESG assets as more and more attractive – including low carbon, energy efficient properties.
This could be all that’s needed to kickstart the full virtuous circle of green lending for retrofit.
But, investors would need reliable property emissions data for potential investments for it to work.
As it stands EPC ratings are used as the industry standard measure of the environmental impact of a UK home.
This immediately poses difficulties for investors who:
- Operate in multiple countries. EPCs are only relevant for UK homes – an American investor may not even know what an EPC is.
- Operate across multiple asset classes. EPCs are only relevant for properties, making it difficult to compare their environmental impact against other types of investment.
Plus, EPCs are well-known to be incomplete (49% of UK homes don’t have a valid EPC certificate), outdated, and inaccurate.
Importantly, EPCs are a measure of the energy costs associated with a home, used as an indicator of energy efficiency – but not an indicator of the carbon emissions associated with the property.
The reliance on poor EPC data has held back the virtuous circle at every step:
- Investors have been unable to asset the climate-related risk and potential of residential mortgage-backed securities on energy efficient homes due to a lack of reliable emissions data from issuers
- Mortgage lenders have had no pricing incentive from investors to promote green mortgages or to offer retrofit loans to drive customer retrofits to increase the number of green assets in their books
- Homeowners have been unable to cover the upfront costs of retrofit without the widespread availability of retrofit financing
- The UK housing market has remained carbon intensive and progress towards net zero targets has been delayed.
An accurate and complete view of property emissions data carbon emissions is needed to kickstart the cycle by giving clarity on climate risks and opportunities for property assets.
We have that dataset at Kamma.
