Scaling Green Retrofit Housing Finance

The Institute for Sustainable Futures (ISF) has proposed a “regulatory nudge” to unlock financing for green retrofits for low-income earners.

With energy prices spiking, householders that wish to make green retrofits to their homes but don’t have access to spare cash risk being exposed to an unfair “net zero poverty premium”.  

Affordable, accessible credit that enables households to sustainably retrofit homes can support the transition to net zero emissions in a way that reduces household energy costs and is consistent with the way that housing finance is regulated. Affordable, accessible credit also supports a just transition to renewable energy.

Scaling Green Retrofit Housing Finance argues that for Australian financial institutions to be able to offer households the opportunity to finance green retrofits at the most cost-effective interest rate, housing loan interest rates, there is a need for Australia’s regulatory framework to support innovation.

ISF’s research considers the potential for “regulatory nudges”, small changes to regulation that aim to unlock the capacity of Australian banks to provide finance to existing housing loan customers. By demonstrating that green retrofits have the potential to improve credit risk by reducing customers’ energy bills, this would provide an evidence base for the Australian Prudential Regulation Authority (APRA) to issue prudential guidance to banks.

To support the issuance of regulatory guidance, ISF suggests that APRA build a Green Retrofit Finance Housing Model to test the impact of loan extensions and deferrals on credit risk. We propose that APRA identify a cohort from the lowest loan repayment quartile that have low loan to valuation ratios, high liquidity buffers and mortgage payments that are not in arrears that would be eligible for a pilot. These three factors combine to identify low risk customers from a bank perspective.  

An example of a green retrofit housing loan extension would be to provide finance to housing loan customers to enable them to replace gas appliances in their homes. A housing loan could be increased by as little as $5,000 with benefits to the household in terms of reduced bills whilst also supporting Australia’s transition to net zero emissions. By demonstrating that the increase in finance reduces a household’s costs of living bank credit risk is improved.

Key insights:

The structure of lending influences household decisions

One impediment to households accessing finance for green retrofits is the way lending products are structured. Residential housing loans are the most cost-effective sources of financing as loans are secured against the housing asset. If customers are not able to access the lowest available interest rates, then there will be less demand for green retrofits.

The challenge for households is that when a housing loan is approved by a bank to purchase, or refinance, an existing house, the need for the householder to make future green retrofits is not included as part of the loan contract. If customers are required to reapply for their loan to access finance this acts as a significant disincentive and pushes customers towards products that have shorter terms for repayment or higher interest costs. This has the potential to deter households from investing in a green retrofit.

Green retrofits can reduce household costs

Evidence shows that green retrofits can reduce household costs over the retrofit’s life. For example:

• More than half of all Victorian homes use energy derived from gas. The Victorian Government estimates that switching from gas to electric appliances could reduce average household energy bills by around $1,250 per year.  
• ISF research found that domestic hot water use is responsible for around a fifth of Australian residential greenhouse gas emissions and a quarter of household energy use. The phasing out of gas water heaters in homes would provide consumers with combined annual savings of $4.7-6.7 billion by 2040.
• Climate Council analysis reveals that electrifying a home’s cooking, heating and hot water combined with practical efficiency upgrades would save between $1,119 and $2,872 each year, while reducing greenhouse gas emissions by an average of 37.5 tonnes over a decade.  

Green retrofits should improve credit risk for banks

Integrating green retrofits into residential lending practices has the potential to improve credit risk for a bank portfolio in two ways. A reduction in energy bills for households improves a bank’s serviceability ratios, whilst the increased value of a house as a result of the retrofit improves a bank’s loan to valuation ratios. Further, banks are being driven to decarbonise their residential lending portfolios to meet their net zero commitments — scaling retrofits is an essential component.

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