Energy Ratings Already Shape Your Mortgage, and Climate Risk Is Next

For most homebuyers, the mortgage negotiation feels like a conversation about income, interest rates and credit history. According to new research from Aalto University in Finland, it is increasingly a conversation about the building itself. The study, published in the Journal of European Real Estate Research, finds that a property’s energy performance rating is already woven into lending decisions at major European banks, and that physical climate risks such as flooding, wildfires and heat waves are expected to become the next major factor determining who can finance a home and on what terms. The researchers interviewed 25 green finance experts drawn from large European banks and real estate advisory firms, and their testimony paints a picture of a lending market in which environmental performance has quietly moved from a marketing label to a core underwriting variable.

The technical backbone of this shift is the Energy Performance Certificate, or EPC, a document that has existed across the European Union since 2002. An EPC grades a building’s energy efficiency on a scale, and for years it functioned mainly as an informational tool for buyers and tenants. That changed in 2020, when the EU Taxonomy, the classification system that defines which economic activities count as environmentally sustainable, came into force. From that point on, the criteria for judging the greenness of buildings were anchored very heavily in EPC ratings, and banks began relying on those criteria to make green lending decisions. A high rating can open the door to green loans and somewhat more favourable financing terms, while a poor rating can push a property into a risk category that makes financing difficult or, in extreme cases, impossible.

The mechanism behind this is straightforward risk arithmetic. A property with a very low energy rating is likely to require significant energy renovations and other investments, and its value is expected to decline over time as regulations tighten and buyers increasingly discount inefficient stock. From a bank’s perspective, that combination of looming capital expenditure and depreciating collateral is unattractive. ‘In practice, a property with a very poor energy rating may not qualify for a loan at all, because banks may consider it too high-risk,’ says Maria Holopainen, a doctoral researcher at Aalto University. ‘Properties with a high energy rating that qualify for green lending may, in turn, receive somewhat more favourable financing terms than conventional loans.’ In other words, the EPC has become a de facto credit signal, one that most consumers do not realise is being read.

Seppo Junnila, Professor of Real Estate Economics at Aalto University and a co-author of the study, stresses that this is not a future scenario but a present reality. ‘For people taking out a mortgage, or considering buying a home, it is important to understand that the environmental performance of the property already affects banks’ lending decisions and loan terms,’ he says. His warning extends beyond energy performance. While the current focus of lenders is squarely on efficiency ratings, Junnila notes that in the longer term, access to more favourable financing is likely to depend on a wider range of environmental sustainability criteria, broadening the set of building attributes that can make or break a mortgage application.

The next frontier, according to the banking experts interviewed, is physical climate risk. Where transition risk, the risk associated with decarbonising the building stock, is currently measured largely through energy ratings, physical risk refers to the direct exposure of an asset to floods, wildfires, heat waves and other extreme weather events. The researchers found that banking professionals expect these hazards to become the next major factor affecting the financing of homes and other properties. Crucially, however, the perception of how severe and important these risks are varies enormously with geography. A bank’s assessment of a property’s climate exposure depends both on where the asset sits and on the region in which the bank itself operates, meaning that identical houses can face very different lending environments depending on their location.

Southern Europe illustrates the point vividly. ‘In southern Europe, climate risks, especially wildfires, heat waves and floods, already carry considerable weight, and there are concerns that they could create inequalities between different residential areas,’ says Holopainen. Recent severe flooding in Sweden has also raised awareness of these risks in the Nordic countries, a region long insulated from the worst physical impacts by its temperate climate. ‘The building stock in the Nordics is comparatively energy-efficient and therefore less likely to be exposed to transition risks than other parts of Europe,’ she explains. ‘However, physical climate risks may become more important in the near future.’ The implication is that the geography of mortgage risk is shifting: regions that scored well on transition metrics may find themselves newly exposed as insurers and lenders begin pricing in floods and fires.

Perhaps the most counterintuitive finding of the study concerns renovations. The European Union has set ambitious renovation targets, and from a sustainability perspective, upgrading existing buildings is widely regarded as far superior to demolition and new construction. ‘From a sustainability perspective, renovations are a far better option than new builds, in fact they are essential if we are to reach the agreed on climate targets and carbon neutrality by 2050,’ says Holopainen. ‘High-performing new buildings alone are not enough.’ Yet the current financial system pushes banks in the opposite direction, encouraging them to finance new properties rather than energy renovations of the existing stock, a structural contradiction that sits at the heart of Europe’s decarbonisation challenge.

The reason lies in the mechanics of the EU Taxonomy itself. New properties can achieve an A energy rating and therefore meet the criteria for being considered green with relative ease, which gives banks an advantage when they raise their own financing in the market, since green-labelled loan portfolios are increasingly attractive to investors. Financing renovations, by contrast, is riskier for banks, and reporting renovated properties as green is also technically more challenging, because the environmental benefit must be documented across a messier, project-by-project process rather than certified at completion. Holopainen argues that addressing this contradiction would require both stronger regulatory guidance and greater pressure from markets, investors and consumers to reward renovation lending rather than penalising it.

The study also reveals something about how banks are adapting to this changing landscape: reactively rather than proactively. The criteria for green lending are shifting, but institutions are largely responding to regulatory developments as they arrive rather than anticipating them. Banks cite the current geopolitical situation and regulatory uncertainty within the European Union, including uncertainty around the easing of sustainability reporting requirements, as obstacles to progress on sustainability in banking. This hesitancy matters because the direction of travel is clear even if the pace is not, and institutions that delay building expertise in climate-adjusted lending may find themselves repricing entire portfolios once physical risk data becomes standard in underwriting.

Underlying all of these findings is a distributional question that the researchers frame in stark terms. There is a real risk, Holopainen suggests, that expensive, energy-efficient and high-quality new homes will increasingly be bought by wealthy households and investors, while lower-quality and higher-risk properties are left to people who cannot afford more expensive homes. ‘This would mean that people who are already in a stronger financial position would be the ones benefiting from more favourable financing,’ she says. ‘The question is how to ensure that people in more vulnerable financial positions can also access sustainable homes.’ As energy ratings and, soon, climate risk scores become embedded in mortgage pricing, the housing market risks splitting into a green premium tier and a stranded, hard-to-finance remainder. For buyers, the practical takeaway is immediate: the environmental performance of a property is no longer a footnote in the purchase decision but a factor that can determine whether the purchase happens at all.

Subject of Research: The influence of building energy performance and physical climate risk on European residential mortgage lending

Article Title: Your home’s energy performance is already affecting your mortgage––soon climate risk will too

Article References: Your home’s energy performance is already affecting your mortgage––soon climate risk will too. (n.d.). Original publication

Image Credits: AI Generated

DOI: Not provided

Keywords: mortgage lending, energy performance certificates, EU Taxonomy, green finance, climate risk, Aalto University, real estate, energy renovations, banks, sustainability, housing inequality, flood risk