We seek to contribute to this strand of research by using a loan-level data set that we combine with information on building energy efficiency and document whether there is indeed evidence of a reduction in default rates for borrowers living in energy-efficient buildings and whether this reduction is greater for lower-income borrowers. Regarding the former two channels, our findings suggest that energy efficiency might play a significant role with regard to default risk either due to unobservable borrower characteristics or the additional cash flow from energy savings. Following the findings of An and Pivo ( 2020), we address the latter channel by controlling for contemporaneous LTV. There are three potential channels that might drive the results: (i) personal characteristics of the borrowers captured by the choice of an EE building (e.g., environmental consciousness) (ii) improvements in building performance that help free up a borrower’s disposable income through lower utility bills and thus reduce default risk and (iii) the positive effect on the dwelling value and thus on the loan-to-value ratio (LTV), which lowers default risk. With this paper, we aim to shed light on this aspect by focusing on the residential mortgage market and examining the correlation between EE and the probability of default (PD). If EE provides significant information to predict mortgage default, then banks or other financial intermediaries (such as fintech companies) should incorporate this information into their credit scoring models. Understanding the importance of EE to mortgage default is critical. While the positive relationship between EE and sales prices is well documented, it is less obvious whether EE has an impact on borrower credit risk. Both groups of buyers demand a greater discount for less energy-efficient buildings and price energy certifications into property values. Footnote 2 Support comes from studies around the world documenting that homebuyers and commercial investors recognize the contributory value of increased energy efficiency. Footnote 1 From the perspective of mortgage lenders and investors, who have shown growing interest in “green”, “sustainable”, and “energy-efficient” products in recent years, investing in building performance improvements seems to be an attractive market segment. Therefore, the improvement of buildings’ energy efficiency (EE) is among top priority measures that can contribute to meeting EU’s commitment to reduce energy consumption and greenhouse gas emissions. These aspects are not only crucial for shaping future energy policy, but also have implications for the risk management of European financial institutions.īuildings account for 40% of EU energy use (European Parliament and Council 2010) and it is projected that 75–90% of the EU building stock will still be standing in 2050. This suggests that the energy efficiency ratings complement borrowers’ credit information and that a lender using information from both sources can make superior lending decisions than a lender using only traditional credit information. The results hold for a battery of robustness checks. In particular, we find that the default rate is lower for borrowers with less disposable income. There are three possible channels that might drive the results: (i) personal borrower characteristics captured by the choice of an energy-efficient building, (ii) improvements in building performance that could help to free-up the borrower’s disposable income, and (iii) improvements in dwelling value that lower the loan-to-value ratio. Using the logit regression and the extended Cox model, we find that building energy efficiency is associated with a lower probability of mortgage default. To this end, we construct a novel panel data set by combining Dutch loan-level mortgage information with provisional building energy ratings provided by the Netherlands Enterprise Agency. We investigate the relationship between building energy efficiency and the probability of mortgage default.
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