Solar Loans - Choose the Smart Way to Pay
A solar loan provides a key differentiator from a lease, ownership. With ownership comes another major benefit, added home equity. A recent study from Lawrence Berkeley National Laboratory highlighted clear data that adding solar that is owned by the homeowner adds $4/watt of home equity to the house. So if you have a 5kW or 5,000 Watt system, that’s $20,000 of added home equity to your home.
Solar Borrowing 101: Loans are Not Always What They Seem
In order to maximize the savings of a purchased solar system, homeowners have to consider various factors including price, size, and hardware. There are two basic options: pay cash or obtain a loan. Solar systems typically cost $20,000 or more, and we find few customers are willing to pay the entire purchase price up front. Most elect to finance the purchase. Some homeowners will go directly to a lender obtain a solar loan. Our Solar Financing Guide provides an in-depth overview of all the options for residential solar projects.
The first thing you should know is that most solar loans allow for a homeowner to apply the federal tax credit toward paying down the loan balance. The lenders typically allow between 12 and 18 months after the funding of the loan for the homeowner to pay back up to the total amount of the tax credit (30% of the purchase price). For example, if a solar system cost $20,000 and was fully financed by a lender, the homeowner would be allowed 12-18 months to pay back up to $6,000 without any pre-payment penalties. This allows for the homeowner to have filed his federal taxes and received a refund, if any was due, and then pay down the loan balance with the proceeds of the tax credit.
So, what should you look at amongst the various solar loans available? There are two prominent considerations:
- The true Annual Percentage Rate (APR) of the loan.
- The monthly payments.
The first of these can be tricky. Some lenders tout extremely low nominal rates (some as low as 1.89%). These sound too good to be true – and they are. Because what they don’t tell you is that there is something known as a ‘dealer fee’ embedded in the quoted price of the solar system. These dealer fees can run as high as 17%, and the homeowner is typically unaware that their system’s price has been increased to accommodate this fee. Despite its name, the dealer fee does not benefit any third party, or dealer; rather, it goes right into the pocket of the lender. One prominent solar lender claims to offer a 2.99% APR on its 12 year loan. That sounds great to many borrowers, but the reality is that the effective interest rate they are paying on the true cost of the system is over 6.3%. This is more than double the advertised rate! So, be careful with dealer fees; ask your installer about them before you sign your contract.
Some solar loans are made with what is known as a “same as cash option.” This means that the lender will fund the full amount of the loan, but only collect payments based on 70% of the outstanding balance during the first year or so. This amounts to a 30% discount on your payments for the first 12-18 months. (This makes Day One savings greater than on a traditional loan.) After that point, the homeowner is expected to pay down the loan balance by the amount of the tax credit. In the example used earlier, the homeowner would receive a $20,000 loan but only pay interest on $14,000. If at the end of the 12 month grace period the homeowner fails to pay back the tax credit amount, then the lender will start charging interest on the $6,000 portion from that point forward. But be careful, some lenders will charge retroactive interest back to the first day of the loan. This can be a very unpleasant surprise!
Solar Borrowing 101: Loan Maturities
Let’s talk about the loan maturities which are typically available in the market. On the short end, you will find 5 year loans, not unlike many car loans. At the long end, there are several 20 year maturities and even a few 25 year solar loans, looking more akin to a home mortgage. There are numerous offerings in between these extremes. So, how to decide amongst all these options? For starters, it should be understood that short-term loans have lower interest rates than long-term loans. A typical 5 year loan may have an effective APR in the 6% range, while a 20 year loan will have rates closer to 8%. It doesn’t seem like a huge difference, but over the course of the respective loans’ lifetimes you might end up paying $12,000 more interest on the 20 year loan on a typical system.
You may ask, why not simply opt for the shorter term loan? The reason is simple: the longer the term, the more time the borrower has to pay down the principal balance of the loan. This allows for smaller monthly payments, a feature many people find attractive. Table 1 below illustrates this dynamic, using actual loan offering from lenders active in the residential solar market. (Assumes purchase of a $20,000 solar system.)
While the 8-year loan featured above has a fairly low lifetime interest cost, the monthly payment will probably not allow for immediate savings on the solar system. That is, the solar system’s monthly payment may actually be higher than the electricity cost which it eliminates. Most people find this to be very unattractive, and opt for a loan with a lower payment. But for a borrower taking a long-term view, the shorter term loan may actually be the best option; because at the end of 8 years he or she will be paying zero for solar, with 100% of the electric savings staying in his pocket. Since solar systems generally have an expected life of 25 years (or longer), that’s at least 17 years of free energy being generated by the panels.
However, if your goal is to maximize cash savings from the moment your system is turned on, then the 20 year loan makes more sense. Many installers have a lender and loan product they are most comfortable using, and tend to promote this without consideration of the homeowner’s needs. Homeowners tend to be too preoccupied with the specifics of the solar equipment they are purchasing to ask questions about the loan they are being offered, particularly the loan maturity. Make sure you look at the loan and maturity options available. If your installer does not give you an array of options, do some research and find an alternative which better suits your needs and preferences.
Good Debt or Bad Debt?
Many financial advisors encourage consumers to avoid debt in most cases, or to at least evaluate whether a debt is good debt or bad debt. In the case of solar, there is compelling evidence that solar debt is a unique case of good debt.
How Stuff Works defines good debt as: “an investment that will grow in value or generate long-term income”. Examples include a college education which will significantly increase your earning power, or a mortgage for a home which will lock in your cost of living and is expected to increase in value over time.
By that same definition, solar is a very good investment. Solar.com’s Bid Generator provides estimated costs of a local PV system and total lifetime savings. That same 5kW system which typically costs less than $20,000, will save you over $50,000 over the 25-year life of the of the system, equal to the length of the solar panel warranties. That’s $50,000 of money not going to your utility, or even your solar lease provider, but to your own pocket, savings, retirement, vacation fund or otherwise. Add to that the $20,000 of home equity that you can capture if you sell your home anytime in the next 25 years, including tomorrow!
The most popular loan with Solar.com customers has a 12-year term, no pre-payment penalties, and interest rates of 2.99-4.99% depending on your credit score. The 12-year term is common because for most customers, their monthly loan payment is equal to or less than their current utility bill. This makes considering solar a similar decision to renting versus buying a home. One of the primary drivers of home ownership is building personal wealth by applying mortgage payments to your loan principal outstanding as well as the long term rising value of real estate.
With all this in mind, consumers can rest assured with a solar loan. Even if they are working an aggressive debt free plan, a solar loan is far superior to a solar lease or your current utility bill.
Affordable Solar Loan Providers
The first homes to install modern photovoltaics were in the 1960s. These early adopters were pioneers in alternative home energy. They took a risk installing new technology. Costs were high and paid in cash. Lucky for them, their financial investment paid off. Those sturdy panels are still producing to this day.
Since those first systems were purchased with cash, the industry has grown and evolved. The solar financing industry has grown parallel to the mass adoption of home solar systems. As more people are looking into alternative energy options for their homes, more financial institutions are seeing opportunity.
Over the years, trends in solar financing have come and gone. For the first 5 years of this decade, the prevalence of Leases (also known as Power Purchase Agreements) rose to prominence. The solar installation company owned the solar system and simply sold the power to the homeowner at a lower rate than their current utility. This was a great way to have solar on your home without any initial cash outlay. Additionally, homeowners could see immediate monthly savings making it appealing to many.
However, solar leasees are not able to take advantage of the 30% Federal Incentive Tax Credit (ITC). Only those who purchase and own the system can receive that credit. This reality has led to a decline in leases and PPAs over the last two years.
Financial institutions saw an opportunity in this coverage gap – they could finance the purchase of a photovoltaic system entirely, and allow homeowners to take advantage of the Federal ITC. For many solar-minded homeowners, this is the best of both worlds.
In the current solar market, there are many new solar financing options available. There are options for those with low credit scores, those with some cash to put down, those who want to pay off their loan quickly, those who want a greater immediate savings, etc.
Here’s a solid foundation for the available solar funding options out there. Check out our comprehensive guide on how to finance solar panel installations.
PACE Solar Loans
In the U.S. today, there is a program called PACE (Property Assessed Clean Energy). It is a government assistance program – which varies state to state – which is aimed at making solar more accessible to lower income or credit challenged households. PACE allows homeowners to use their home as collateral to finance their solar system.
Note, finance rates are higher for this type of loan. Therefore, it is typically not a good option unless all other routes have been exhausted. If your debt to income ratio is not optimal, a PACE loan might be the right choice to go solar. PACE financing still pencils out for many homeowners with sky high utility bills.
One main benefit of financing through PACE is that,should the home be sold, the balance of the solar loan transfers to the new homeowner. It is a relatively simple process for both the seller and buyer.
Examples of PACE programs in California include:
Each of these financiers have very similar loan structures and terms, but vary slightly with interest rates and serviceable areas.
For a more traditional loan – where your house is not used as collateral – there are three separate options: re-amortized loans, combo loans, and SREC loans.
Re-amortizing Solar Loans
Re-amortizing loans are independently financed through a financial institution. This loan type allows a homeowner to re-amortize their loan logo-1.jpgonce. Most homeowners use their tax credit amount to re-amortize the loan at tax season the following year. However, a homeowner does not have to re-amortize with their tax credit. Technically, this loan option can be re-amortized whenever and with any amount of money.
A typical lien is not placed on the home. Home liens can be a problem for some homeowners. Rather, a UCC1 fixture filing is placed on the solar system itself to secure the loan. This is often viewed as a safer, more prudent alternative to a home lien.
Examples of Re-amortizing Loan Financiers:
Combo Solar Loans
Much like re-amortizing loans, combo loans are independently financed. The main difference is that (in lieu of re-amortizing a single loan) there are two separate loans. The first loan is for 70% of the contract price, which has an interest rate (for which the homeowner qualifies). The mosaic.png
second loan covers the remaining 30% of the contract price. This second loan is meant to equal the federal tax credit amount and typically lasts for 18 months with 0% interest. If this amount is not paid off in that allotted time frame, the balance adopts the same APR as the first loan, whatever that may be.
The main advantage to a combo loan is that the homeowner starts off with a lower monthly payment as compared to a re-amortizing loan. This can be helpful for homeowners where consistent solar loan payments are helpful for budgeting purposes.
Examples of combo loan financiers:
SREC Compatible Loans
For homeowners in a few U.S. states, there is a special program for which they are eligible. When the solar system generates 1 MWh (1,000 kWh), one Solar Renewable Energy Credit (SREC) is created. In each state with the program, these credits can be sold on their state’s open SREC market. They are regionally specific and only available in a handful of states.
SREC Compatible Loans are those that take these credits into account when financing the cost of the system. These financiers offer two options for how SRECs are calculated into the loan offering. The homeowner can choose either a complete upfront buyout for the value of the SRECs (lump sum), or an offer for a ‘fixed monthly product’. In this second option, the financier spreads the value of the solar system’s SRECs over the duration of the loan.
Much like the combo loan option, these options provide the homeowner with a consistent monthly payment that does not change over time. It is helpful for those on a restricted budget or those who strongly prefer consistent payments each month.
Examples of SREC Compatible Financiers: