Secured vs. unsecured solar loans: How to choose

There are many different types of solar loan products that you can use to finance the installation of a solar panel system. But despite the plethora of options, you can generally bucket all these loans into two broad categories: secured and unsecured solar loans. Your home equity backs secured loans but not unsecured loans.

With a secured solar loan, your lender will require that you promise an asset–usually your home–as collateral for the money you borrow. This essentially provides "security" to the lender if you can't repay the loan. So, if you take out a secured loan and default on payments, the lender holds a lien on your property, allowing them to take possession of it to pay off the loan.

Secured loans overview

Because secured loans use your home (or another asset) as collateral, secured loan lenders assume less risk than they would if your loan was unsecured. Many secured loans have lower credit score requirements than their unsecured counterparts. Additionally, many secured solar loan providers don't require any money down, and most do not impose prepayment penalties should you decide to pay off your loan early. One of the biggest advantages of a secured loan is the tax benefits: Interest paid on many types of secured loans (e.g., home equity loans and home equity lines of credit) is tax-deductible.

Here are some key things to know about secured loans:

• Popular secured loan types Include home equity loans and lines of credit, FHA loans, and PACE financing. Local credit unions and national lending institutions also offer solar loans.

• Secured loans typically have lower interest rates than unsecured loans.

• For many types of secured loans, interest is tax-deductible.

• Secured loan options usually require significant equity in your home, a strong credit rating, and a favorable debt-to-income ratio.

• If you finance with a secured loan, the lender may be able to repossess your home if you default on payments.

• Secured loans often have a longer closing process (up to several weeks).

Are secured loans right for you?

A secured solar loan may be right for you if:

• You are primarily concerned with long-term loan value rather than short-term cash flow.

• You want to maximize the financial benefits of your solar panel system.

• You have enough home equity to pay for a solar power system and are comfortable using your home as collateral.

• You have a tax liability large enough to take advantage of tax-deductible interest.

• You can wait a few weeks to close the loan.

There are four main types of secured loans: home equity loans, home equity lines of credit, FHA loans, and PACE loans. Here's what to know about each type:

Home equity loan

Often called a "second mortgage," a home equity loan is a loan that uses your home as collateral. A home equity loan lets you borrow against the value you have accrued in your home since its purchase and is often used for major home improvement projects. Home equity loans provide a fixed amount of cash, repaid through monthly payments at a fixed interest rate.

Home equity line of credit

With a home equity line of credit, the bank gives you a line of credit via a credit card or checkbook rather than providing you with the entire loan amount in cash upfront. You can draw on the line of credit over an agreed-upon term. The interest on both home equity loans and home equity lines of credit is tax-deductible. Most home equity loans and home equity lines of credit have a fixed term length of 5-15 years.

FHA loans

Some lenders offer secured loans insured by the Federal Housing Administration (FHA). Similar to a home equity loan, FHA-backed loans are secured by your home, and the interest you pay is tax-deductible. They can be used for many home improvements, including solar panel installation. However, unlike home equity loans, if you default on an FHA-backed loan, the bank will not foreclose on your home because it can collect insurance from the FHA for up to 90% of any loan.

PACE loans

Some local governments provide PACE financing for solar and other home energy projects. A public agency provides the capital for the loan, and you repay the loan through assessments added to your property tax bill over 10 to 20 years.

As of 2019, 36 states, plus Washington, D.C., have enacted legislation that authorizes PACE programs.

With an unsecured solar loan, you can borrow money from a lender to install a solar panel system without putting a lien on your house. The penalty for defaulting on the loan is more minor – they do not require collateral, and the lender cannot foreclose on your home. However, this comes at a price: because they are riskier options for lenders than their secured counterparts, unsecured loans often have higher interest rates.

Unsecured loans overview

Finding an unsecured loan with good value is well within reach. Many unsecured loan providers ask for no money down and won't charge interest on any money you get back from the investment tax credit (ITC).

Here are some key things to know about unsecured loans:

• These loans do not require your home as collateral.

• They're a good option if you're unable or unwilling to use a secured loan.

• Unsecured loans have less long-term value than secured loans.

• If you default on an unsecured loan, the lender can hire a collection agency and ding your credit score.

• Unsecured loans may have hidden origination fees.

• Unlike with secured loans, interest paid is not tax-deductible.

• You can be approved for an unsecured loan in minutes.

Are unsecured loans right for you?

An unsecured solar loan may be right for you if:

• Your priority is to maximize your cash flow in the short term

• You don't have enough home equity to cover the cost of a solar panel system, or you want to save it for other purchases

• You are not comfortable with using your home as collateral

• You don't have the tax liability to take advantage of tax-deductible interest

Still not sure which loan is best for you? Ask yourself these questions:

Are you willing to use your home as collateral for a secured loan?

While a secured solar energy loan will have lower total costs than an unsecured loan, you must be willing to use your house as collateral. If your financial outlook is uncertain or you are concerned about your ability to repay a loan, a secured loan may not be for you.

An unsecured loan is better than a secured one if you don't have enough home equity for a second mortgage, would rather save your available home equity for other purchases, or are uncomfortable using your home as collateral.

Do you have enough home equity for a secured loan?

Banks use the balance you owe on your first mortgage and your home's appraised value to determine the loan amount for a home equity loan. If you've already borrowed against the equity in your home or still owe most of your mortgage, you may want to consider an unsecured loan or a solar lease/PPA.

What are the loan interest rates?

Typically, interest rates on secured loans are lower than those of unsecured loans because your home backs them. Your secured solar loan will likely have an interest rate between 3-8%, depending on your credit score.

With unsecured loans, sometimes contractors "buy down" the interest rates, which may result in significant hidden markups in the loan amount. By directly comparing your financing options on the EnergySage Marketplace, you can quickly determine the total costs associated with secured and unsecured loan options.

What are the loan terms?

With secured loans, second mortgages typically have term lengths of 10 to 15 years, although some can be as long as 20 years. Unsecured solar energy loan terms can run from 5 to 20 years.

Loans with longer term lengths have lower monthly payments, but you will pay more interest over the loan term. Be sure to compare your financing options to find the right product.

How do the overall economics compare between loan types?

Secured loans generally have better interest rates and term lengths than unsecured loans. Assuming your financial situation is secure, you can get a loan to start saving money immediately.

Because unsecured solar panel loans do not require collateral, they are a higher risk for lenders and tend to cost you more. However, you can still take out unsecured loans that allow you to save immediately by dramatically reducing your electricity bill.

What are the loan fees?

For secured loans, banks charge approximately $1,000 in fees for solar panel systems, which can include:

• Property appraisal fees

• Application fees

• Closing costs such as attorney's fees, title searches, and mortgage preparation and filing

• An origination fee, calculated as a percentage of the overall loan

Lenders offering secured loans must disclose all fees and miscellaneous loan charges upfront. However, unsecured solar loans with low-interest rates may have significant markups or come with undisclosed fees that the solar installer pays the bank or lender. Often, these fees do not appear as a line item on solar loan quotes. These fees can vary dramatically and be significantly higher than secured loan fees.

What tax benefits come with solar loans?

As with a first mortgage loan, the interest you pay on home equity loans, home equity lines of credit, and FHA solar energy loans may be tax-deductible. Depending on your tax liability, these tax savings can be substantial.

However, unlike secured loans, the interest on unsecured solar loans is not tax-deductible.

What happens if you need to sell your home?

With most secured loans (excluding PACE loans), you must pay off the loan's balance when you sell your home. Secured loans can be repaid at any time without any prepayment penalties. Research suggests that homes with solar panel systems sell at a premium, which can help you recover your initial investment.

Because unsecured loans are not tied to your home, you can sell your home and move before the end of the loan term. However, you are still responsible for paying the loan off. As with other personal debt, unsecured solar energy loans stay with the person rather than the property and can't be transferred to the new homeowner.

How long does it take to get a solar loan?

Lenders approve unsecured loans quickly – often in just minutes. Secured loans usually take much longer to close.

How long does it take to close a secured loan?

Second mortgages may take several weeks to close, mainly due to the logistics involved in appraising the value of your home. Some secured loan programs may also require you to complete a home energy audit and make energy efficiency upgrades before the solar panel loan can be approved.

What happens if you default on an unsecured loan?

You will not lose your home, but your credit score may be impacted if the lender reports your non-payment to credit rating agencies.

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