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How to Pay for Solar – Financing Options Explained

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A world without energy is almost impossible to imagine. It would be a world without computers, factories, microwaves, and our most beloved gadgets, mobile phones. The world runs on energy. This energy can come from various sources, some of which are renewable while others are non-renewable; some are highly polluting, while others are comparatively less polluting. Irrespective of the source, energy powers the world around us. But good things are rarely free of cost, and energy generation is no different. Apart from the monetary costs, energy generation can have substantial environmental costs associated with it.

To counter the environmental impact, communities have been moving toward more sustainable sources of energy generation and solar energy has emerged as the leading choice. Many factors make solar more popular than wind, hydropower, geothermal, or biomass:

  1. Availability – Solar energy is available throughout the year in most parts of the world.
  2. Accessibility – Solar energy is accessible to everyone; geothermal, biomass, and hydropower are not.
  3. Affordability – Harnessing energy from solar for self-consumption is affordable compared to the other options. Biomass is affordable, but daily accessibility is currently a roadblock.

Though installing solar is more affordable than other energy sources, it is still relatively expensive. Solar is an investment that pays for itself over the years and helps reduce your carbon footprint. Upfront payment can be prohibitive for many, so customers often turn to financing. Let’s explore the most common financing options available today.

Loan – Loans are the market’s most popular solar financing method today. In loan-financed cases, the customer owns the system and receives all the incentive benefits applicable to their case.

The market is flooded with lenders, each offering 100s of different types of loans. Loans with shorter maturity usually have lower interest rates, but the monthly payments of such loans are typically higher. Longer-maturity loans have higher interest rates, but the monthly payments are typically lower. Other options have no interest, no payment for the first few months, and bulk re-payment of the total amount after that period. Customers can choose from a variety of loan options best suited for their financial situation.

Below are short descriptions, along with examples, of different loan types commonly used for solar financing:

  1. Solar loans – Solar loans have lower initial monthly payments because it is assumed that the customer will prepay a certain percentage of the loan amount before a predefined period. If this prepayment is not made, the monthly payment increases. The most common prepayment amount equals the Investment Tax Credit (ITC) benefit (30% of the loan amount) and is expected to be paid back before 18 months. This loan is ideal for customers who are sure they can make the prepayment. Example – If the loan amount were $20,000 and prepayment was 30% ($6,000) by the 18th month, the initial loan payment would be calculated assuming a loan amount of $14,000 (the remaining 70% of the $20,000). For a 25-year, 2.99% loan, the initial monthly payment would be $66.32. If the customer prepaid the $6,000 before the 18th month, the first-period payments would remain the same in the second period. If the customer did not prepay by the 18th month, the loan payment would increase to $97.32.
  2. Mortgage loans – Mortgage loans are the opposite of solar loans. They start with regular loan payments but if the customer prepays a certain percentage of the loan amount before a predefined period, the loan payments decrease. Like solar loans, the most common prepayment amount is equal to the ITC benefit (30% of the loan amount) and is expected to be paid back before 18 months. This type of loan is ideal for customers who are unsure of their ability to make a lump sum prepayment but want to keep the option open. Example – If the loan amount were $20,000 and the prepayment was 30% ($6,000) by the 18th month, the initial loan payment would be calculated on the total loan amount of $20,000. For a 25-year, 2.99% mortgage loan, the initial loan payment would be $94.74. If the customer prepaid the 30% ($6,000) before the 18th month, the second-period payments would decrease to $65.09; if the customer failed to pay the 30%, the loan payments would continue at $94.74
  3. NINP loans – NINP stands for No Interest, No Payment. This option is like a deferred cash payment. These loans have a 0% interest rate during the initial period with the condition the customer prepay the total loan amount before the said period ends. Users must make a monthly payment if the total loan amount is not pre-paid by the said period, and interest is charged for the initial period. This loan is ideal for customers expecting sufficient cash inflow soon (within the NINP period), allowing them to repay the loan in full, thus saving any interest costs. Example – If the loan amount were $20,000 and the NINP loan had a 12-month, no interest, and no payment period, the customer would pay nothing for the first 11 months but must pay the total loan amount ($20,000) before the end of the 12th month. If the customer did not pay the total loan amount by the end of the12th month, interest would be charged for the first 12 months at a predefined rate, and the customer would be required to make a monthly payment for the next few years (as defined in the loan agreement).
  4. Principal-only loans – Principal-only loans have a promotional period with 0% interest. If the customer repays the total principal during that promotional period, their effective APR will be 0%. If the principal is not fully repaid in the promotional period, a predefined interest rate applies to the remaining principal amount. This loan is ideal for customers expecting an influx of cash flow, allowing them to pay the loan amount in full during the promotional period, thus saving on interest costs. Example – If the loan amount were $20,000, for a 60-month principal only/20-year – 2.99% loan, the loan payment for the first 60 months would be $70 and increase to $110 in the second period (assuming no other lump sum payment). To achieve a 0% APR, the customer would have to pay $334 monthly during the first 60 months. Fastpay by Goodleap is an example of a principal-only loan.
  5. Interest-only loans – Interest-only loans have a promotional period during which the customer needs to pay only the interest. Once the promotional period ends, customers must pay interest and principal. This loan is ideal for people who want a lower payment initially but can afford a higher payment after a few months. Example – If the loan amount were $20,000, with a 60-month interest only/20-year 2.98% loan, the loan payments for the first 60 months would be $49.67 and increase to $137.93 in the second period (assuming no other lump sum payment). Flexpay by Goodleap is an example of such a loan.

Leases – Leases are another popular method of financing solar installations. Like loans, they are typically used when a customer does not have the resources to pay for the system upfront. But unlike loans, lease-financed systems are third party-owned (TPO).

Monthly lease payments depend on factors like lease terms, lease escalation, buyout clauses, and other terms and conditions related to incentive benefits. Therefore, customers should read the fine print while comparing lease options.

Essential information to consider when evaluating lease options:

  1. Lease Term – This is the period for which the initial lease is signed. Longer lease terms typically result in lower lease payments as longer contracts reduce uncertainty for the TPO.
  2. Lease Escalation – Most leases include an escalation rate. Customers should pay careful attention to the lease escalation rate as a higher escalation rate may make the lease costly. Ideally, the lease escalation rate should be lower than the utility bill escalation rate.
  3. System Buyout – Some leases include a buy out of the system after a few years. The buyout term and amount are defined in the initial contract. Buying out a system transfers the ownership from the lessor to the lessee. Post-buyout, monthly lease payments are not required.

Power Purchase Agreement (PPA) – PPA is another solar financing option gaining popularity. PPAs are like leases in the sense that the customer does not own the system, but unlike leases, customers do not pay a predefined fixed monthly amount. PPAs have predefined per kWh rates, and the customer’s monthly payment is calculated based on the monthly production and $/kWh rate.

Essential information to consider while evaluating PPA options:

  1. PPA Term – This is the period for which the initial PPA contract is signed. Longer lease terms typically result in lower PPA rates per kWh as longer contracts reduce uncertainty for the TPO.
  2. PPA Escalation – Most PPA contracts include an escalation rate. Customers should pay careful attention to the PPA escalation rate as a higher escalation rate may make the PPA costly. Ideally, the PPA escalation rate should be lower than the utility bill escalation rate.

Compare Financing Options

*Dependent on contract terms. If the incentive benefit goes to the TPO provider, lease/PPA payments are lower, and if the incentive benefit goes to the customer, lease/PPA payments are higher.

In conclusion, ownership (Cash and Loan) is ideal for customers who own the property and can apply for applicable incentive programs to extract maximum benefit.

Note: if the customer has cash surplus, paying upfront is a better option than taking a loan. In most cases, cash funded systems provide better ROI and a shorter payback period than loans because:

  • Loans incur interest
  • Loans have a dealer fee

TPO-based models (Lease and PPA) are ideal for customers who do not have cash to pay upfront, do not own the property, or cannot apply for incentive programs.

Note: a lease is more advantageous for customers who want to lock in a monthly payment upfront while a PPA is more advantageous for those who want to pay based on system output.