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Hard to Treat Homes and ECO Mortgages

January 2012

The problem of insulating hard to treat homes looks to be one of the insoluble elements of the Green Deal / ECO programme. On the one hand, insulating solid wall homes either externally or internally is likely to lead to some of the greatest gains in energy efficiency and fuel cost saving; on the other  hand the cost per treatment (between £6500 and £10,000) looks prohibitive as far as either Green Deal or ECO is concerned. Solid wall insulation will clearly break the 'golden rule' as far as Green Deal is concerned in that the cost of a treatment (let us say, for example that it comes out at the median price of £8500) will not, in itself recover enough in energy costs saved to finance the treatment. General estimates of savings obtained from homes treated under CESP suggest that annual recovery of perhaps £350 - £400 in heating costs is possible – a very impressive reduction and a strong decline in emissions – but as far as the Green Deal 'golden rule' is concerned, a non-starter. A 'Green Deal' package at even the 6% proposed by the Green Deal Finance Company requires at least £480 per annum to be found in interest – a starting gap of £80 -£150 even if no other work on the property is undertaken.

It might be possible to develop 'hybrid' packages of Green Deal finance plus - say- an ECO top-up, but the figures do not look encouraging. Green Deal finance could fund perhaps £6000 of the total without breaching the 'golden rule' and the other £2000 would need to be found from an ECO top-up. And here we would need to look at the scale of the problem to be addressed to put that sort of financing into context.

DECC references and validates the target of the Climate Change Committee for the proportion of the 7 million solid wall homes in the UK that will require treatment to enhance their energy efficiency and contribute towards climate change targets. It states that ‘the committee on climate change recommended in their 2009 report ‘meeting carbon budgets – the need for a step change’ that 2.3 million solid wall homes will need to have taken up solid wall insulation by 2022 in order for the UK to be on track to achieve carbon budgets’. (DECC Extra Help’ May 2011 p.6). But even if Green Deal plus packages were to be set up for solid wall insulation, the ambition of 2.2 million homes treated by 2022 would consume a huge part of any available budget, at the expense of most other activity on Green Deal and, for that matter, ECO. Reaching this target would imply the treatment of about 230,000 homes a year at a cost of £1.4 billion per year in green deal finance and £575 million pounds of ECO money. Alternatively, it might be considered that such a huge drain on available Green Deal finance is unsustainable and that hard to treat homes should be funded through ECO: but this would draw out £1.95 billion from ECO alone per year, which will be in excess of the whole ECO budget. There would also, quite rightly be criticism of such a blanket approach to ECO, which is supposed to be allocated for the twin purposes of alleviating fuel poverty and underpinning hard to treat homes (DECC Extra Help p. 3). Even assuming ‘super Green Deal’ arrangements were put into place, more than half of the available ECO budget of more than £1 billion per annum would be addressed to ‘could pay' hard-to-treat homes to the exclusion of substantial numbers of homes in fuel poverty, and if ECO alone were to be used, clearly there would be no room for fuel poverty initiatives, even on a more generous estimate of available ECO finance.

Even though it is true that there is something of a congruence between those in fuel poverty and those living in hard to treat homes either the target would need to be abandoned or very little fuel poverty alleviation would result from ECO. Clearly a source of funding for these measures outside of both ECO and Green Deal would need to be found if the ambition is to be approached with any hope of success.

The Climate Change Committee, in its 3rd Progress Report (p. 118-119) identifies such a source – mortgages, currently running at an interest rate way below that of even the best 'Green Deal finance' arrangements. The Committee reports that some 45% of homes have a loan to value ratio of fewer than 65%. Although the Climate Change committee presents the idea of using mortgages to bear at least some of the post of external (or internal insulation, it does not develop the concept very much further. It assumes that 'financing ...2 million solid wall insulations through mortgage rather than green deal finance could result in cost savings of up to £4 billion by 2020’.

However, a cursory look at what happens next after the concept is placed on stage demonstrates that more needs to be done to develop such an idea. An £8500 25- year capital and interest mortgage, for example, at present rates of interest will cost something like £44 per month or £528 per year. Raise the interest rate a little as is likely to happen over the next few years, and the cost at 5% goes up to £48.50 per month or £585 per annum. Just as it is considered unlikely that a householder will invest in a Green Deal energy saving programme that places a greater charge on his/her electricity bill than is recouped in saved fuel cost (i.e. 'the golden rule'') it is equally unlikely that a mortgage decision such as this would work easily if there remained a gap of £150 per year between bill reduced and mortgage payments outlaid. There would be some perceived premium in the likely overall value of the property being enhanced, but it would be a bridge difficult to cross. To gain the sort of mass-buy-in that the Climate Change Committee requires, there would need to be some incentive provided.

This could come in the form of an 'ECO golden rule’ – that is, that the householder should repay on an additional mortgage, no more than the saving he or she would make on energy bills. This implies, therefore that an external source of finance would be necessary for (on present rates) £150 of the mortgage bill per year. This payment could, quite simply come from ECO. That is, instead of advancing lump sums for a small number of houses, small 'top-ups' could be advanced on a far larger number of properties. These advances needn't be on the whole lifetime of the loan, since the value of the saving on energy bills over the longer period (assuming energy prices rise faster than other prices) will enhance over time: a ten-year incentive would probably be attractive enough to householders.

Such a system would transform the finances available to pursue solid wall insulation through ECO. Put simply, a far larger number of homes could be supported through ECO than is presently possible, and even over a ten year period a ratio gain of about eight to one would be achieved. Green Deal finance would also not be used, preserving it for deals financed under present arrangements or, perhaps for deals on housing association and publicly owned properties.

Could this system conceivably support an ambition of 2.2 million homes insulated by the early 2020s? Assuming a 'target' of 200,000 per year through the mortgage market and, perhaps 30,000 through 'super Green Deal' arrangements for public sector homes, then financing 'Golden Rule' ECO would look as follows:

The maximum exposure at year ten would be £300 million, and the cumulative exposure would be £1.65 billion, averaging £165 million per year. After ten year, exposure would probably fall unless similar programmes to insulate similar numbers were  to be undertaken, but would not exceed £300 million per year. To this should be added the cost to ECO of underpinning perhaps 30,000 ‘super green deals’ – a stable annual total of £60 million, or £600 million over a ten year period. If a small amount for administration of such a programme were added, on average, it would cost less than £250 million per year, far less than even intervening in ‘super green deals’ for all hard to treat homes, but attaining the Climate Change Committee’s target over the period.

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