The Federal Housing Administration will stop insuring new mortgages on homes with PACE loans, a type of controversial financing used to fund energy-efficient home improvements.
The announcement Thursday follows criticism from consumer groups that too many borrowers have taken out unaffordable loans for solar panels and other projects after contractors misrepresented how the financing works.
In announcing the policy change, the FHA said PACE loans lack sufficient consumer protection and put taxpayers at risk. When a borrower with an FHA-backed mortgage is foreclosed upon, the portion of the PACE loan in arrears must be paid off first.
The remaining PACE loan transfers to the new buyer, but the FHA said that increases the likelihood the buyer will pay less, making it more difficult for the agency to meet its obligations.
"Assessments such as these are potentially dangerous for our Mutual Mortgage Insurance Fund," Housing and Urban Development Secretary Ben Carson said in a statement.
In a statement, Renovate America, the largest PACE lender, said that the policy change only affects a fraction of its business and that PACE borrowers do not default on their mortgages more frequently than those without a PACE loan.
First started in 2008, PACE, or Property Assessed Clean Energy, programs are typically established by local governments, which tie the privately financed loans to the home and allow them to be repaid as line items on property tax bills. The loans in California can also be used for items such as low-flow toilets that save water.
In Southern California, Los Angeles, Riverside, San Bernardino and San Diego counties have approved PACE lenders to operate.
California has taken steps recently to boost consumer protections.
In October, Gov. Jerry Brown signed two bills that, among other things, bar kickbacks to contractors who serve as sales people and include a first-time requirement that a borrower's income factor into underwriting.
The FHA now joins the Federal Housing Finance Agency, which has barred Fannie Mae and Freddie Mac from purchasing mortgages on homes with PACE loans.
Homeowners who already have an FHA-backed mortgage can still take out a PACE loan, but the FHA said it is concerned about that as well.
"FHA intends to monitor this carefully to determine whether further action is warranted," the agency said in a news release.