Analysis from Bank Underground shows that the higher a property’s energy efficiency rating, the less likely the mortgage borrower is to fall into arrears.

Bank Underground is a blog used by Bank of England staff to publish views that don’t necessarily coincide with the Bank of England’s. In the blog’s latest post, the authors set out to study the relationship between the energy efficiency level of properties and mortgage defaults.

Here is an overview of the blog:

A well-insulated house reduces heat loss during cold winter periods and it keeps outdoor heat from entering during hot summer conditions. Hence, effective insulation can reduce the need for households to use cooling and heating systems. While this can lower greenhouse gas emissions by households, it also reduces homeowners’ energy bills, which can free up available income. This can protect households from unexpected decreases in income (e.g. reduced overtime payments) or increases in expenses (e.g. healthcare costs). It could also help homeowners to make their mortgage payments even if such shocks occurred. But does this also imply that mortgages against energy-efficient properties are less credit-risky?

Analysis borrower-level data on mortgage arrears matched with property-level energy ratings

We examine this question using loan performance data for residential mortgages in the entire UK (year-end 2017) which we match with the energy performance certificates (EPCs) of the underlying properties. We add information on the income of the borrower at the time of mortgage origination. The final sample of matched mortgages consists of more than 1.8 million observations.

EPCs provide information on the annual energy costs of a property. Buildings need them whenever they are built, sold or rented. EPCs rate properties from A (most efficient) to G (least efficient). We categorise properties into three buckets: ‘High energy efficiency’ (EPC ratings of A, B or C), ‘Medium energy efficiency’(EPC rating of D) and ‘Low energy efficiency’ (EPC ratings of E, F or G). For example, the annual energy bill of a highly energy-efficient 4-bedroom house is on average GBP 1,080 lower than for a 4-bedroom house with low energy efficiency.

Table 1. Annual energy costs (in GBP) by type and energy efficiency of the property

Type of property High energy efficiency Medium energy efficiency Low energy efficiency
(EPC rating A-C) (EPC rating D) (EPC rating E-G)
2-bedroom flat 417 676 1,023
3-bedroom house 578 891 1,340
4-bedroom house 695 1,130 1,775


Our evidence suggests that mortgages on efficient properties are less risky

Simple univariate comparisons suggest that about 0.93% of residential mortgages against energy-efficient properties are in payment arrears. This share is 0.21 percentage points lower than the share of mortgages against energy-inefficient properties, which is 1.14%. This difference is statistically significant at the 1 percent level. In graph 1, the black dot illustrates this difference. The black bar shows the 99% confidence interval. We provide an interactive version of this graph here.

Graph 1. Difference in mortgage arrears (high energy efficiency vs low energy efficiency)

Two mechanisms could be driving this difference. On the one hand, energy bills are lower on energy-efficient properties. Savings on energy bills could lead to lower arrears rates (‘energy savings effect’). Alternatively, high-income borrowers could be more likely to take out mortgages against energy-efficient properties. Such borrowers may fall into arrears less frequently (‘incomeselection effect’). To examine the relevance of the ‘income selection effect’, we compare mortgage arrears of borrowers with similar income. Practically, we control for borrower income at origination in a multivariate regression analysis (see technical appendix for further details). The difference in payment arrears of mortgages against energy-efficient properties compared to mortgages against energy-inefficient properties remains similar (grey cross in bar 2). So the ‘income selection effect’ does not explain lower mortgage arrears for mortgages against energy-efficient properties.

To test the robustness of our findings, we also control for property characteristics (indicators are property type and whether the property is newly built, the number of rooms, the number of heated rooms and the floor area of the property) and contract-specific characteristics (the loan-to-value, loan amount, property price). The difference in payment arrears remains qualitatively similar (blue arrow in bar 3).

Additionally, we control for year of mortgage origination and EPC inspection. The difference in payment arrears between mortgages against energy-efficient properties compared to energy-inefficient properties decreases in magnitude to -0.10 percentage points. It remains statistically significant at the 1 percent level. This suggests that these factors can explain some but not all of the correlation between energy efficiency and mortgages arrears (orange square in bar 4).

We conclude that the energy efficiency of a property is a relevant predictor of mortgage risk

Overall, these results suggest that mortgages against energy-efficient properties are less frequently in arrears. Mortgage borrowers’ income at origination cannot explain this difference. However, the dates of mortgage origination and EPC inspection do explain some but not all of this correlation. We conclude that the energy efficiency of a property is a relevant predictor of mortgage payment arrears.

Does this imply that there is a causal relationship between higher energy efficiency and lower mortgage payment arrears? Not necessarily. Yet, some banks have started to price mortgages against energy-efficient properties at lower rates, implying a lower risk premium. For example, a bank in the UK started offering lower interest rates to mortgage borrowers buying energy-efficient new-build homes in the UK this year. Besides, several European banks have teamed up to run a pilot initiative, which rewards buyers of greener certified homes with lower interest rates on their mortgages.

Table 1. Multivariate analyses: energy efficiency and mortgage payment arrears

Dependent variable Arrears Arrears Arrears Arrears
Column (1) (2) (3) (4)
High energy efficiency (0/1) -0.0021*** -0.0024*** -0.0020*** -0.0010***
(0.0002) (0.0002) (0.0002) (0.0002)
Medium energy efficiency (0/1) -0.0014*** -0.0017*** -0.0014*** -0.0004**
(0.0002) (0.0002) (0.0002) (0.0002)
Gross income (thousand GBP) -0.0001*** -0.0000*** -0.0000
(0.0000) (0.0000) (0.0000)
Joint income (0/1) -0.0005*** -0.0007*** -0.0040***
(0.0002) (0.0002) (0.0002)
Age of borrower (years) 0.0000** 0.0000*** 0.0000***
(0.0000) (0.0000) (0.0000)
Property control variables No No Yes Yes
Contract control variables No No Yes Yes
Regional control variables No No Yes Yes
Origination year control variables No No No Yes
Inspection year control variables No No No Yes
Observations 1,833,653 1,826,399 1,826,399 1,826,399
R-squared 0.0001 0.0005 0.0005 0.0049
Mean of dep. variable 0.0103 0.0103 0.0103 0.0103