Your business is built on your reputation. In order to protect that reputation, it’s important that you can rely on your finance partner to evaluate whether a solar loan is the right fit for your customer.
Assessing a borrower’s ability to repay is the cornerstone of any responsible consumer lending program. Debt-to-income (DTI) is the standard metric used to ensure that prospective borrowers have adequate cash flow to meet a new debt obligation. As the industry matures, the solar financing industry is increasingly incorporating this key metric.
How is a debt-to-income ratio calculated and what does it measure?
Here is the basic concept: Add up all the monthly inflows of cash. Typical elements of household income include W-2 salary or income derived from being self-employed, rental income, social security and pensions. Separately, add up all the existing monthly obligations of a borrower. Typical monthly obligations or debts include mortgage payments, auto loans, student loans and credit cards. The debt-to-income ratio is simply the number that relates debt (in the numerator) to income (in the denominator).
You’ll notice that what is not included in the calculation is general living expenses such as food, taxes, entertainment, gasoline, insurance premiums and cell phone bills. In other words, a borrower with a 100% DTI has no funds remaining to cover general living expenses after they have met their existing monthly obligations.
A healthy debt-to-income ratio is below 25%. Debt-to-income ratios between 25% to 45% are considered borderline. Debt-to-income ratios over 45% may be considered a red flag depending on the context such as the absolute level of income.
Why do responsible solar lenders assess DTI when solar saves homeowners money?
Here’s why: Solar is a great value proposition for many people. That doesn’t mean that solar saves people money every month.
1. Solar tax credits are not guaranteed
We know from years of talking with homeowners and solar salespeople that tax credits are among the most complex parts of the solar value proposition. Why is that the case? At the time of the solar sale, no one knows whether homeowners will in fact receive a refund check. This is because we don’t how the solar tax credit interacts with the rest of a homeowner’s tax circumstances.
For example, consider a homeowner with a substantial tax bill which is being offset by a solar tax credit. The homeowner is benefitting from the solar tax credit but does not receive a cash infusion. And yet with most solar loan products, the homeowner has an obligation to repay the tax credit portion of the loan within the first 18 months of the loan.1 From where is the cash to make that lump sum payment coming if the homeowner did not receive a refund check? If the homeowner is not able to make a full repayment of the tax credit portion, the borrower’s monthly payment for their solar loan will increase.2
Evaluating your customers’ debt-to-income ratios allows us to ensure that even if your customers are not able to repay the tax credit portion in full and their monthly payment increases by up to 30%, they will have enough income to cover their solar loan payment without hardship.
2. Seasonal variation in load and production
In cold climates, heating bills may soar and the solar arrays may be snow-covered. On the other end of the spectrum, heat waves may send the cost of cooling homes through the roof while solar production may be diminished. In both of these cases, solar savings may be lower than typical. And yet a standard solar loan payment is still due.
Looking at your customer’s debt-to-income ratio allows us to feel confident that your customer will be able to make a regular monthly loan payments despite the natural ebb and flow of solar savings.
We understand that selling solar requires us all to keep it simple. Often times this means talking about saving a certain $ amount per month. That’s OK, but it’s our job to make sure that we understand and plan for the various scenarios that your customers will regularly experience when they go solar. Tax credits and seasonal changes are just two of the many scenarios that can affect the monthly math for your customers.
Beware of “fast food” solar loans
For solar veterans, assessing a homeowner’s DTI ratio may be an unexpected addition to the financing process; after all, solar lease/PPA providers typically relied on FICO score and did not evaluate DTI. Relying on FICO scores makes sense in the case of third-party ownership given that homeowners do not qualify for the tax credit. In other words, we don’t have to contemplate what happens to the monthly math if homeowners don’t receive a refund check; we know they won’t receive one!
With PACE financing, the industry learned a hard lesson when state legislators introduced new requirements on financiers. Initially PACE providers neglected to evaluate whether borrowers actually had the ability to repay their PACE assessments. The results have been negative press for the industry, discontinuation of PACE programs in counties across California as complaints mounted, and an unfortunate boom and bust cycle for contractors reliant on the financing option.
In other words, fast food solar loans may taste good now but are not healthy for growing a sustainable business.
2 Some lenders will also penalize borrowers who do not pay off their tax credit portion in full by increasing their APR. At Sungage, we offer all borrowers our ‘soft landing’ feature – no penalties, no increase in APR no matter how much of the tax credit portion is paid off.