Green Heat Finance Taskforce: report part 1 - November 2023

5. Overview of Current Market Financing Options

A range of financing mechanisms is currently in use in the energy efficiency and ZDEH markets. These different instruments, structures and products are currently being implemented either separately or in packages and offer potentially useful lessons for financing the transition to ZDEH heating and installation of energy efficiency measures for different types of buildings and ownership models in Scotland. Summary information on the applicability of each of these mechanisms is provided in Tables in section 5.1 below with further detail on each in Annex 2.

Some of these mechanisms will already be used extensively and will not, therefore, be new concepts to consumers, rather their application to finance green housing improvements will be more novel. We recognise, though, that many of the products discussed in more detail in this report, particularly secured or unsecured loans, will only be accessible to individuals who will be able to afford the repayment terms, even for those products that have no significant upfront fee. For those who are able to pay, the ability to access affordable finance is important because it enables them to act now, this also supporting market development more broadly.

Many people in the able to pay group already self-finance either through their own savings or recourse to loans to cover the costs of installing a new gas boiler, with many retailers offering interest free finance options. Other financing options will be less familiar to consumers, being currently unavailable in Scotland, such as heat as a service, or are available but predominantly used at a larger organisation level, for example, bonds (both of which will be discussed in more detail in the Taskforce’s Part 2 Report) .

While the individual products outlined below all have their own merits, it is worth noting that, in practice, delivery models are likely to incorporate a variety of mechanisms and funding sources. International experience suggests that it is unrealistic to focus on purely private finance mechanisms to drive transformational change in new areas like heat. Rather, different forms of public concessional and private finance solutions are required^[27]. Individuals may also require combinations of the products summarised below over the lifecycle of any energy efficiency or ZDEH solutions installed.

5.1 Summary of possible financing options (descriptions of each product below can be found in Annex 2)

Grants

Summary description: grants are funding provided by Scottish Government or other third parties for use on a particular activity like installation of ZDEH measures with no need to repay the grant funding (providing conditions are complied with).

Used by Private sector (incl. households)

Yes

Used by public sector

Yes

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

Yes

How well developed in market (1- little or no; 3- strong)

3

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: Scottish Government currently provides grants through various programmes (see Annex 2), helping reduce upfront costs for eligible individuals. Grant could be combined with other sources of finance including traditional loans or ‘green mortgages’. The scale of funding required to grant fund installation of ZDEH and energy efficiency measures across all properties is likely to exceed the level of available Scottish Government budget.

Traditional Self-financing (including unsecured lending)

Summary description: individual sectors / property owners source their own financing requirements through traditional channels for undertaking ZDEH measures, for example, through unsecured bank loans, by means of credit cards or selling any stocks or shares owned.

Used by Private sector (incl. households)

Yes

Used by public sector

No

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

3

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: able to pay property owners could finance installations through traditional financing sources, such as loans or rental income, without the need for further support or new ‘green’ specific financing solutions. Most property owners are likely to have access to these more traditional financing routes and will be familiar products to them. The extent to which they are used is likely to depend on the associated cost of any ZDEH works.

Green Loans or mortgages (secured lending)

Summary description: offered by lenders, including banks, to existing domestic and non-domestic customers for specific measures related to green or environmentally sustainable upgrades. ‘Green mortgages’ generally provide additional secured lending available to individuals from their existing mortgage provider to finance green upgrades to their homes.

Used by Private sector (incl. households)

Yes

Used by public sector

Yes

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

2

Further considered in this report

Yes

Suitability to finance energy efficiency and ZDEH: one of the more common forms of green financing for energy efficiency and ZDEH, although still a developing area. Particularly for domestic properties, many providers are currently considering their offerings and testing new products, expecting increased future market demand, particularly as these can support meeting ESG requirements of finance institutions. A more established range of green loans is available to non-domestic building owners.

Equity Schemes

Summary description: enables people over 55 years old to access tax-free financing by releasing equity in their home; that is, giving up a partial ownership stake or agreeing to repay a certain amount to a third party in the future in return for an upfront cash receipt and being able to continue living in the property as long as they wish. The financing can have many potential uses, including the funding of ZDEH solutions.

Used by Private sector (incl. households)

Yes

Used by public sector

No

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

NA

How well developed in market (1- little or no; 3- strong)

1

Further considered in this report

Yes

Suitability to finance energy efficiency and ZDEH: there is considerable equity value held by property owners. Releasing some of this, particularly amongst older householders, could pay for ZDEH installations and may provide an option for those who have asset wealth but limited income. Other potential costs, such as boosting income in retirement, or to fund future care needs, are amongst the considerations people would need to think about in deciding on the suitability of equity release products.

Property Linked Finance

Summary description: Property Linked Finance (PLF) can support homeowners to fund up to 100% of the upfront costs of energy efficiency improvements – with the unique characteristic that the finance is linked to the property, rather than the property owner – which results in payment obligations transferring to the new owner when a property is sold. Underpinning PFL is the principal that the person benefitting from energy efficiency measures at any given moment is responsible for the PLF payments.

Used by Private sector (incl. households)

Yes

Used by public sector

No

Source of direct finance

Yes

Tool to 'crowd-in' or support low-cost private sector capital

Yes

How well developed in market (1- little or no; 3- strong)

1

Further considered in this report

Yes

Suitability to finance energy efficiency and ZDEH: PLF is a financial solution where the payment obligation is linked to the property, rather than the property owner. The transfer of finance with changes in building ownership could overcome a key challenge of efficiency upgrades known as the “payback period barrier”, whereby homeowners looking to move in the short to medium term are deterred from making energy efficiency upgrades as the costs of repaying the upgrades are greater than potential energy bill savings while they still own the property. While not currently available in the UK, a form of PLF is widely utilised in USA, Australia and Canada to finance property upgrade works.

On-bill Repayment

Summary description: provides a mechanism whereby utility providers invest in, or provide customers with, the financing to undertake energy efficiency upgrades. Customers then pay for those upgrades through a charge on their energy bill over a set period of time. Works generally have to be carried out to an agreed standard and/or through an approved list of contractors. Tends to be focused on individual households, rather than non-domestic customers, where mechanisms like Energy Performance Contracting may be more applicable.

Used by Private sector (incl. households)

Yes (domestic)

Used by public sector

No

Source of direct finance

No

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

1

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: Scottish Government unable to apply this with current devolved powers. Mechanism was used as part of the UK ‘Green Deal’, but proved challenging to deliver at scale. Given the integrated UK energy market, it is also likely to be something best applied at a UK-wide level.

Heat as a Service

Summary description: private sector suppliers provide finance investment and install ZDEH measures, with property occupants paying a contracted monthly amount for a combination of the upgrades, heat provision and/or maintenance. Sometimes referred to as a Heat Pump on Subscription model, although there is no reason why the model has to be limited to heat pumps as the ZDEH technology.

Used by Private sector (incl. households)

Yes

Used by public sector

No (although similar to EPC contracting)

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

Yes

How well developed in market (1- little or no; 3- strong)

1

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: by shifting customers away from buying fuel, towards paying an energy supplier for a service, potentially including ZDEH equipment and maintenance, it offers a possible route to deliver ZDEH, although requires scale to be economically viable for supplier. The financing would be provided by the supplier, with repayments being supported from income from service agreements with the domestic customer.

Dedicated Property and Investment Funds

Summary description: a type of fund that invests in rental property or other real estate assets, including commercial property. Can be open-ended, meaning they accept investment at any time; or closed-ended, with a limited number of shares. Property funds can be traded in financial markets and can provide a return for investors through selling their stake at a higher price than for what it was purchased, or through dividends, which are generated by the underlying assets in the fund (rental income, revenue from property sale, etc.).

Used by Private sector (incl. households)

Yes

Used by public sector

No

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

3

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: open and closed-ended property funds are a well-established and regulated financial mechanism, trading on the London Stock Exchange and can comprise particular types of property. This could include funds focused on properties converting to ZDEH. Commercial considerations around the rates of return and scale of properties – both domestic and non-domestic, which could comprise the under-lying assets – will determine the market appetite to establish ZDEH focused property investment funds. It is likely that ‘green’ property funds will evolve naturally over time as the number of ZDEH buildings increases.

Energy Performance Contracting

Summary description: agreement between a customer (e.g. Registered Social Landlord (RSL) or private sector landlord) and an energy services company which provides energy efficiency upgrades, across multiple properties, or buildings to an agreed standard – typically designing, installing and maintaining the upgrades – to deliver an agreed reduction in energy consumption levels with the customer, paying a monthly service charge for the duration of their contract. Energy Performance Contracting (EPC) agreements aim to ensure the energy bill savings post-upgrade are sufficient to cover the monthly costs to the service provide. An initial payment from the customer may also be required.

Used by Private sector (incl. households)

Yes (non-domestic)

Used by public sector

Yes

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

2

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: used by the non-domestic sector, particularly the public sector, although the model does have potential for use in the domestic sector too if scale for delivery across multiple properties could be guaranteed (for instance with RSLs or larger private sector landlords). Benefits of EPC contract include: the customer not having to fund the upfront costs of the upgrades, project risks being transferred to the energy services company, and having a guarantee of the level of energy savings being delivered, as future repayments are tied to the energy service company delivering the agreed outputs.

Green Bonds

Summary description: raising finance from financial markets by issuing debt (in the form of bonds) which is then repaid by the bonds issuer at agreed interest rates over time to all purchasers of the bonds. The financing raised by issuing the bonds must then be used for the purposes stated in issuing it, for example, to finance ZDEH upgrades. Repayments must made to investors as per the bonds’ conditions irrespective of the income the bond issuer receives on the activities they delivered with the finance the bonds raised. Bonds can be issued by private sector organisations of scale, or public sector organisations with borrowing powers (such as local authorities).

Used by Private sector (incl. households)

Yes (corporate)

Used by public sector

Yes

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

2

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: might be useful for larger organisations, including local authorities, although requires a sufficiently large pipeline of deliverable projects to make it cost effective. Scottish Government currently has limited borrowing powers and is unlikely to utilise bonds in any meaningful way to finance ZDEH installations.

Revolving Loan Funds

Summary description: public sector lead mechanism whereby individuals or businesses apply for funding in the form of a loan, which is then repaid over time, providing a repayment stream to replenish the fund for future funding rounds. Potential to attract additional third party (private) money to increase the scale of the fund.

Used by Private sector (incl. households)

Yes

Used by public sector

Yes

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

Yes

How well developed in market (1- little or no; 3- strong)

1

Further considered in this report

No

Suitability to finance energy efficiency and ZDEH: a form of co-investment mechanism that could attract larger scale institutional investment and offer scope to aggregate loans (coupled with frameworks for installation, quality assurance and service standards). Funds could be structured and focused in a way to support policy goals.

Fiscal mechanisms

Summary description: not a direct form of financing, rather the use of taxation to incentivise desired behaviours. It could encourage investment by providing monetary benefits to undertake works, or alternatively penalise those who do not adhere to the encouraged behaviour (the latter potentially then providing funding to subsidise retrofit programmes). Could include taxation powers such as Land and Building Transaction Tax for domestic properties or Non-Domestic Rates for non-domestic properties.

Used by Private sector (incl. households)

Yes

Used by public sector

Yes

Source of direct finance

No

Tool to 'crowd-in' or support low cost private sector capital

No

How well developed in market (1- little or no; 3- strong)

1 (to incentivise ZDEH)

Further considered in this report

Yes

Suitability to finance energy efficiency and ZDEH: taxation is widely used internationally to promote behavioural change in line with a government’s objectives and could, in theory, encourage people to retrofit their properties, although limitations on the Scottish Government’s taxation powers may constrain the potential effectiveness of fiscal levers in Scotland.

Guarantees and First Loss Capital

Summary description: public sector support through use of guarantees, or first loss capital, in a Joint Venture or co-investment vehicle, with the aim of reducing risks for private sector finance providers sufficiently to encourage them to offer relevant funding to individuals and/or businesses. First loss capital is where the Scottish Government accepts the risk of covering a given level of loss (or non-repayment) before other fund financers suffer any loss, thus reducing the risks they face in offering finance. It may help de-risk the financing of early stage market development.

Used by Private sector (incl. households)

Yes

Used by public sector

Yes

Source of direct finance

Yes

Tool to 'crowd-in' or support low cost private sector capital

Yes

How well developed in market (1- little or no; 3- strong)

1

Further considered in this report

Yes

Suitability to finance energy efficiency and ZDEH: as an immature market, government guarantees and/or uses grant as first loss capital. Could provide a means of crowding-in larger scale amounts of private capital, which can offer an overall lower financing cost for borrowers than purely private capital could, if private providers had to accept all the risk themselves.

There follows a discussion of the key mechanism, drawing on products highlighted in the tables above, which individual building owners may be able to use to invest in ZDEH systems and energy efficiency improvements. We offer the Taskforce’s views on the opportunities for growth that may exist, if those barriers highlighted in the next section can be addressed.

5.2 Traditional Self-Financing (including unsecured loans)

There is a wide range of unsecured loans available through retail banks and building societies, and interest rates can vary significantly depending on circumstances. Unsecured personal loans are typically used to borrow relatively small sums of money and access to them will be influenced by an individual’s credit rating. In the current market, however, they are not widely used for financing energy efficiency and ZDEH installations. This is partly because the Scottish Government provides a range of interest free and low cost loans to various building owners, and, although there has been demand for these Scottish Government products, the Taskforce understands that this has not been at significant enough scale to meet Scotland’s emission reduction targets. This limited demand also helps to explain the low interest in utilising traditional unsecured finance products for ZDEH solutions.

Private sector loans are also available to businesses, including a range of ‘green loans’, in a similar way to personal loans for individuals. These ‘green loans’ enable businesses to invest in a range of environmentally sustainable improvements, with repayment terms echoing those of standard business loans. The Taskforce does not believe these ‘green loans’ are widely utilised in Scotland as SMEs are able to access a loan of up to £100,000 from the Scottish Government, with the zero per cent interest offered on the SME Loan Scheme being better than companies could achieve through commercial lenders. Again, low demand from businesses for energy efficiency and ZDEH works, when considered along with the range of competing demands on business finances, is likely to substantially explain low uptake of privately provided loan funds that do exist.

5.3 Taskforce View on Current Use and Potential Development

Who can currently access them – in theory, traditional self-financing products, such as unsecured loans, are available to everyone, although will be subject to a satisfactory credit check and the repayments being affordable.

Repayment of a personal loan is typically over a one to seven year period, a much shorter repayment period than for mortgage additional borrowing (the main alternative source of home improvement finance). A personal loan will, therefore, generally have higher monthly repayments than mortgage finance, so will only be a suitable source of financing energy efficiency or ZDEH solutions where the overall costs of the upgrades do not lead to prohibitively high monthly payments. Households with low income levels are, therefore, unlikely to find personal loans an attractive financing option, even if they were to pass credit checks. This will rule out many property owners that are in or at risk of fuel poverty, as well as many older householders where individuals are retired or are planning to retire.

Despite the higher interest rate associated with personal loans, a personal loan can cost less than mortgage additional borrowing over the full lifetime of the loan due to its shorter term. Personal loans used for financing a specific good or service also benefit from robust consumer protections under the CCA. Personal loans are also an appropriate source of finance for the approximately 50% homeowners in Scotland that do not have a mortgage.

Personal loans could, therefore, offer a realistic financing option for approximately 1.4 million property owners in Scotland, this representing approximately 55% of overall domestic dwellings. Notwithstanding, such loans would not generally be suitable for more expensive retrofitting works and their attractiveness would be influenced by the terms of a loan compare to alternatives.

While a range of privately provided ‘green loans’ is available for business, these are only likely to be attractive to a smaller proportion of Scotland’s businesses at present. A private loan is only likely to be a suitable option where the total costs of a project exceed the level of interest free loan available through the SME Loan Scheme, or where a company is not classed as an SME. As at March 2022, there were an estimated 360,910 private sector businesses operating in Scotland. The vast majority of these businesses (98.3%) were small (0 to 49 employees). A further 3,835 businesses (1.1%) were medium-sized (50 to 249 employees) and 2,340 businesses (0.6%) were large (250 or more employees)^[28].

How traditional loans might evolve to support ZDEH solutions – there is currently a large array of green loans available in the market for businesses, however, there are very limited domestic products, which are distinguished from ordinary unsecured loans.

There are currently several key barriers limiting the green home loan market in the UK, the main limitations stemming from the CCA and operational challenges. On the latter, a personal loan journey has become streamlined, is often digital-only, and has limited after-sales interaction for the consumer. Assessment of the use of funds adds an additional layer of complexity to a personal loan journey, making it more challenging for a lender, although integrating into a supplier’s platform through “point-of-sale” finance can help streamline this process.

In the short-term, at least, it seems unlikely that there will be any substantial development of personal loans for domestic property owners, notably those focused specifically on investing in environmental sustainability measures. However, traditional personal loans for any purpose could still help individuals bridge any small gaps in the costs of enhancements relative to the scale of public support available.

The Green Finance Institute (GFI) launched the Green Home Finance Principles (GHFPs) a framework of guidelines to support the allocation of finance towards retrofitting works in the UK’s domestic buildings^[29]. Broader adoption of these principles could support the development of new products along the lines outlined above.

GFI role in supporting development of Green Home Improvement Personal loans

Personal loans are a form of credit that are regulated in the UK under the CCA 1974. Some sections of the CCA (particularly sections 56 and 75) lead to significant risks for lenders developing green personal loans as they cause a lender and supplier to be equally responsible for any purposeful or accidental mis-selling, mis-representation, or breach of contract.

As already noted, the potential impact of sections 56 and 75 on green home finance was realised in the UK during early lender activity financing solar panels. Various factors, including a lack of consumer understanding, have led to billions of pounds in liabilities and contingent liabilities still being held on lender balance sheets today. A continuing legacy arising from this time has been a perception by lenders that energy efficiency and ZDEH solutions represent a prohibitively costly risk for to them.

CCA reform is widely considered to be the most critical catalyst for large-scale green personal lending. The UK Government has committed to reforming consumer credit protection laws, and the GFI has been actively supporting and engaging with this reform. However, the length and complexity of the CCA means that reform is expected to take several years and the outcome is uncertain. Nevertheless, de-risking mechanisms that facilitate the rapid development of green loans remains of key importance.

There are potential market opportunities for risk-management mechanisms that support the development of green loans including:

• consistent standards across SME contractors through audited work to help prevent claims; and
• the involvement of the insurance industry for risk management and mitigation insurance that can spread the risk for lenders and suppliers.

The GFI has identified potential risk-management and mitigation solutions with leading market actors and is continuing to actively work cross-sectorally with key stakeholders to develop these solutions. Development of these solutions has the potential to unlock a substantial UK personal loan market for energy efficiency and ZDEH solutions.

5.4 Green Loans or mortgages (secured lending)

Overview – one common area for green home financing is a green mortgage, whereby a bank or mortgage lender offers home owner preferential terms, if they can demonstrate that the property for which they are borrowing meets, or will meet through retrofitting measures, certain environmental standards.

The GFI has been working closely with industry to stimulate growth within the green mortgage market; with just four green mortgage products available in 2019 – when work on the GFI’s Green Mortgage Hub^[30] started – there are now over 60 green mortgage products available from 38 different lenders. These offer a variety of incentives and product features for purchasing, remortgaging an already energy efficient home, as well as a suite of products that allow additional funds to be raised for retrofitting. These span both the owner-occupier and buy-to-let (BTL) sectors.

There are currently two main categories of ’green mortgage’ available on the market. Firstly, products that incentivise through product features such as a discounted rates (typically 0.05 – 0.10%) or by means of cashback of typically between £500-£2,000 (for existing customers that have carried out energy efficient improvements on the security property). Secondly, products based upon enhanced affordability for energy efficient properties, where additional funds of typically up to £25,000 are available to borrow for these purchases, giving potential buyers greater buying power when searching for a property if considering an energy efficient property versus a less energy efficient property.

More widely, as of January 2023, according to Money Facts^[31] there were 533 ‘green’ mortgage products^[32] (as labelled by lenders) available on the market from both high street and specialist lenders. This included loans for landlords and so-called ‘second’ loans, where a mortgage is extended to provide capital for energy efficiency upgrades. The Intermediary Mortgage Lenders Association (IMLA) in its report on Green Mortgages in 2020, stated that these types of mortgages, although in their infancy, are a growing part of the UK financial service sector, and that 14% of brokers have had clients that have enquired about or taken out a green mortgage that offers some type of incentive to customers to invest in energy efficiency improvements as part of taking out a mortgage^[33].

Currently, many green mortgage products that constitute a main mortgage do not offer a significantly lower interest rate than their traditional counterparts, despite emerging evidence that there is a lower credit risk associated with borrowers owning energy efficient properties. As the market is currently considered niche, the competitive effect of suppliers competing for customers, and, thereby, driving down prices is limited, and customers’ decisions on which mortgage products to select, are strongly correlated with costs. This is understandable, particularly given the other large outlays associated with purchasing a property, as well as the wider cost pressures faced by everyone due to current high inflation (and increasing interest rates).

However, finance providers are increasingly exploring the appetite of existing mortgage customers to access additional secured borrowing to fund green improvements to their home. These additional loans generally offer better interest rates that those available through either traditional loans or for full mortgages, with some offering zero per cent interest currently available^[34].

The Bank of England has increased base rates steadily from 0.1% in December 2021 to a level of 5.25% by September 2023. This is likely to have an impact on the housing finance market over the coming year as the higher base rate feeds through into higher interest rates for new mortgages. This would be expected to make consumers even more sensitive to costs when determining which mortgage to take out, suggesting challenges in growing the demand for green mortgages if they do not offer the most competitive overall package for individual property purchasers needs.

5.4.1 Taskforce View on Current Use and Potential Development

Who can currently access them – similar to personal loans, green mortgages (and associated secured lending) are available to all private property owners, subject to individuals receiving a satisfactory credit check, repayments being affordable and having sufficient equity within the property. This applies to private rented landlords as well as owner occupier housing. Again, many older householders, as well as those living in fuel poverty, are unlikely to be attracted to green mortgages as repayment may be unaffordable for such individuals.

Green mortgages can offer an attractive financing model for those able to afford the repayment and who are looking to install ZDEH systems or energy efficiency upgrades. There are, however, other solutions, such as unsecured finance, that provide alternative options which should be assessed individually based on the borrowers’ financial circumstances. While a benefit of a green mortgage is to spread the cost of raising additional funds over typically a longer period, and at a lower interest rate when compared to an unsecured personal loan or credit card, a mortgage would, typically, mean more interest would be paid over the term of the product and also may not be available for older householders, those already in fuel poverty, or those who may be behind with their bills, which would impact their eligibility for mortgage products.

As repayment for secured loans can, generally, be added to a customer’s remaining mortgage period, they offer an opportunity to spread the costs out over a number of years, and, therefore, have potential to help fund work requiring more substantive upfront costs.

Full mortgage products badged as ‘green mortgages’ are sometimes only available to homes that are already highly energy efficient. If this is taken to mean properties with an EPC rating of band B or better, it could potentially offer an option for approximately 85,000 properties across the owner occupier and private rental sectors (out of a total 1.95 million properties in these sectors).

How mortgages and loans might evolve to support ZDEH solutions – the increased availability of secured loans for energy efficiency or ZDEH works, alongside traditional mortgage products, could be a natural growth area if demand for heating enhancements increases substantially. This may even include the total value of mortgage and secured loan exceeding the maximum loan to value ratio which a bank would lend a traditional mortgage against, therefore opening up the possibility of green additional secured borrowing for homeowners who are unable to put down larger deposits, or who have not built up substantial equity in their property.

As the market matures and risks are better understood, we would anticipate that the interest rates charged on the green mortgage or secured loan would be better than the interest charged on a traditional mortgage. This would be driven by competition between providers, as well as more data to validate emerging indications that there are lower rates of credit default amongst households which invest in energy efficiency measures^[35]. Greater demonstration of supply chain capacity and sufficient skilled installers, along with established standards and quality assurance over work carried out, would also help reduce the perceived risk which is currently priced into many green finance products.

On its own, though, the savings from a lower interest rate for a green mortgage product compared to a traditional mortgage (which does not require any green upgrades) may not be significant enough to induce an individual to install upgrades, as the cost of the upgrades are likely to be greater than the level of repayment savings between green and traditional mortgages.

Increased competition between finance providers could lead to a greater availability of secured loan ‘second charge’ products to individuals, even if their main mortgage is with another provider. About 50% of lenders now offer green mortgages and 98% indicated they will offer them in the near future^[36]. As demand is expected to ramp up in the second half of the current decade, many banks are currently developing green mortgages and loan products with the aim of testing and refining them before scaling them up in the coming years.

This is a promising development and one which is worth monitoring going forward. With many lenders choosing to develop green mortgage products using the GFI’s ‘Green Home Finance Principles’ as a framework and voluntary code of conduct, this is bringing structure and integrity to the market as it continues to grow at pace.

Green mortgages could also evolve to become available to property owners not currently living in very energy efficient properties, with cash or interest rebates for installing agreed energy efficiency or ZDEH measures.

GFI activity to foster development of green mortgage market

Green mortgages are a key financial mechanism for connecting homeowners with the finance required to achieve the UK’s Net Zero ambition through decarbonisation of housing stock. Scaling this market requires proactive, sustained, and tailored market interventions, such as the GFI’s green mortgage campaign, which has directly supported growth in the green mortgage market from four to over 60 products within just four years.

Understanding how greater competition would drive innovation, whilst identifying that lenders were hesitant to launching green products due to a perceived risk of ‘greenwashing’, the GFI developed the Green Home Finance Principles to strengthen the integrity of the market and provide the clarity and framework required by lenders during the product design, development and marketing and process.

Resources to inform commercial decision-making on green mortgages were lacking in 2020. Lenders shared frustrations over the lack of widely available information, which they did not have capacity to individually compile. This caused a slowdown of innovation. Responding to this need, the GFI launched the Green Mortgage Hub and Lenders’ Handbook on green home technologies, a comprehensive guide to inform financial institutions and industry about retrofit technologies and funding options.

Recognising that mortgage brokers play a vital role in the market, with 82% of all mortgage origination being intermediated, and in response to demand from leaders in the intermediary market, the GFI also published the Brokers’ Handbook on green home technologies, in collaboration with several finance and retrofit trade bodies, to help educate and raise awareness of energy efficiency and green mortgages amongst the intermediary sector.

The GFI continues to work closely with the mortgage industry, including mortgage lenders, as well as broader stakeholders such as surveyors and valuers, regulators and mortgage sourcing systems, to ensure that the market continues to grow, diversify and provide financial mechanisms and education to homeowners.

5.5 Equity Release Mechanisms

Overview – of the approximate 100,000 house purchases made per year in Scotland, almost 34,000 are mortgage-free transactions, accounting for £7.6 billion^[37], a segment of the housing market for which green mortgage products are not relevant, as these largely relate to older people who have already paid off their mortgages.

Equity release products enable property owners that own their property outright, and are over 55 years of age, to utilise equity in their property to secure a long-term loan. The equity release loan can then be used to fund energy efficiency improvements, although there are currently very few products available in the market that specifically target equity release for green home improvement.

Equity release allows the property owner to release tax-free cash without needing to move out or make monthly repayments. Third party financing is provided to the borrower in exchange for the funder taking an equity stake in the property and may be particularly relevant for mortgage-free owners. The financing is repaid on sale of the property. Such mechanisms can be used in many ways, including to boost income in retirement, pay for caring needs, or to transfer some wealth to children while still alive.

There are two existing types of equity release: Lifetime Mortgages and Home Reversion Plans. Lifetime Mortgages are mortgages (loans) that do not have to be repaid until the property is sold, although individuals may choose to make regular repayments on the interest to reduce the compounded interest payments that would be applied at point of sale, alongside repayment of the mortgage amount borrowed. A smaller proportion of equity release loans are accounted for by Home Reversion Plans, which allow the property owner to sell a proportion of the property, for less than the market value of the portion sold, while continuing to reside in the property. The finance provider receives their cut (or equity stake) when the property is sold.

Equity release products are not, however, suitable for all, and professional advice is required before taking out any equity release mortgage to ensure people understand the downsides and how they relate to their individual circumstances^[38]. An important risk to understand with Lifetime Mortgage equity release products is the potentially significant interest costs a person’s estate may have to pay upon settlement of the agreement. This is because interest compounds and can build up substantially if doing so for several years. Making monthly interest repayments can help reduce the level of compounded interest due upon settlement, while only drawing down the agreed equity release money as required will also help, as interest is only compounded on the money actually borrowed.

Raising less than the market value for the proportion of a property put into an equity release product is an important downside for people to consider with Home Reversion Plans (where interest is not charged, as the provider is not offering a loan, rather taking an ownership stake in the property). The lump sum released may only be about half the market value of the property, even though the equity provider is entitled to the proportionate market share of the property when it is sold. For example, selling a 20% equity share in a property valued at £200,000 might only raise £20,000, while the provider would be entitled to £44,000 if the property was eventually sold for £220,000. The reason for the large discount on market value raised by equity release is because the provider, typically, has to wait several years to get money back, while the discount also protects the provider from negative equity if the value of the property upon sale is less than when the equity was released.

5.5.1 Taskforce View on Current Use and Potential development

A possible source of expansion for equity release products could be to grow the market for equity release products, with a specific focus on enabling investment in energy efficiency and ZDEH systems. The use of such products for decarbonising homes could offer significant benefits in both energy cost savings, as well as making people’s homes warmer and more comfortable to live in, alongside the potentially improved health benefits that arise from this. Consumers could also benefit from the stability of a long-term fixed interest rate with no monthly interest payments.

The Taskforce is aware that there is an increasing demand for later life (for those over 55) lending that can allow consumers to achieve various goals, and includes the following:

• covering long-term care costs;
• carrying out home improvements, essential household repairs and adaptations;
• consolidating burdensome debts; and
• reducing working hours or the funding of earlier retirement.

Making homes more warm, comfortable and Net Zero could be an additional use for homeowner equity.

5.6 Green Leases or Rental Agreements

While not an actual financing mechanism, green leases in the private rented or non-domestic sector are a way to overcome the split incentive barrier discussed in section 4.2.4, by means of including ‘Green Lease Clauses’^[39] in tenancy agreements, which enables the landlord to recover the costs of retrofitting based on the predicted energy savings they will generate.

Existing UK legislation currently constrains what is possible with green leases domestically, as it prevents landlords from charging variable rents or from splitting the energy savings between landlords and tenants. This means that energy alignment clauses are not possible in the UK at present. Notwithstanding, there may be scope to incorporate a type of heat as a service into renal agreements, whereby the tenant pays a fixed monthly cost for rent and services, including energy. It is perhaps worth noting that encouraging behavioural changes in tenants, so as to use energy efficiently, is a challenge associated with such models.

In respect of the potential role for green rental agreements in helping transition to ZDEH solutions, further work is required to better understand what delivery models are possible within the UK, as well as what the attitude of landlords and tenants would be to different models.

While small overall, green leases are becoming more common in the non-domestic sector, with many drawing on the Better Building Partnership’s Green Lease Toolkit. Lessons^[40] from their development in a non-domestic setting – which may be transferable to domestic properties – may form part of any future exploration of their potential.

5.7 Property Linked Finance

Property Linked Finance (PLF) is not currently available in the UK, although could, in the future, support homeowners by funding up to 100% of the upfront costs of energy efficiency improvements, with the unique characteristic that the finance is ‘linked’ to the property, rather than the property owner. A comparable finance mechanism available for home upgrades in the United States has, to date, mobilised over $13 billion of financing towards energy efficiency improvements across 344,000 homes, and 3,100 commercial buildings, creating almost 200,000 skilled job years^[41]. PLF may provide an innovative and scalable financial mechanism, which could potentially mobilise capital towards retrofitting upgrades.

This solution will be particularly relevant for the owner-occupied and private rental sector, where tying the financing of ZDEH measures would result in the benefits and any associated financing costs of Net Zero installations being passed to whoever owned the property at a particular point in time.

The GFI (as one of the Taskforce members) is pioneering the UK’s efforts to launch a PLF scheme, collaborating with some of the UK’s largest financial institutions to establish a prototype solution. The GFI has undertaken research showing that there is appetite from consumers for a PLF-type scheme, both in stable and rising energy price environments^[42]. The Taskforce therefore believes that this mechanism merits further research and exploration, in collaboration with the GFI, in terms of: defining the legal process of linking finance to a property; developing an operational business model; as well as the customer journey, regulatory treatment, housing market implications, and integration with the retrofit supply chain.

GFI role in exploring potential of PLF in UK

Energy efficiency in the built environment has long been a challenge, and the current energy crisis has worsened the situation, thereby increasing the urgency to act. PLF has the potential to help address this challenge.

To understand the UK’s appetite for PLF, the GFI surveyed 1,800 UK homeowners between 2021-22. The GFI’s 2021 research found encouraging levels of demand for PLF with 63% of respondents stating they were likely or neutral to using PLF – an encouragingly positive response to a new financial solution. Of those who were open to using third-party finance for energy efficiency, 73% supported the proposed scheme. Over half the respondents stated that future socio-economic pressures would probably make them more likely to consider using PLF, particularly amongst landlords and younger people.

Based on the positive response from UK consumers, the GFI has developed a mechanism to ‘link’ PLF to the property, and engaged extensively with market experts to inform an early model for UK PLF schemes. The GFI will also work with financial institutions to further develop the PLF model and catalyse pilot projects across the UK.

5.8 Fiscal Incentives

Fiscal incentives are not private sector mechanisms, such as those discussed above. They could, however, form part of a range of measures to encourage the installation of ZDEH, and have been utilised in other countries.

Such fiscal incentives can complement regulations by influencing both the demand and supply sides, given that tax-based incentives have long been used to drive behaviour and purchasing decisions across many markets. While Scotland does not currently have full control over all fiscal powers, property-based taxation such as Council Tax or Land and Buildings Transaction Tax (LBTT) can offer the potential to incentivise behaviour and encourage individual action in relation to decarbonisation. The use of wider fiscal powers – for example, the treatment of VAT on energy efficient works or ZDEH – is something that can only be considered on a UK-wide basis.

The Taskforce would therefore like to see the Scottish Government explore those areas where it does have devolved powers (e.g. LBTT) more fully, where it is able to do so, as well as to work with the UK Government to look at other areas, such as VAT or capital allowances, that are reserved.