Secured vs Unsecured Solar Loans: What’s The Difference?

Understanding the difference between secured and unsecured loans is essential to make well-planned financial decisions. Various financing options are available for individuals like you and many business owners. And, these options are categorized into secured and unsecured loans.

Secured solar loans have the solar system itself or other assets as collateral, where if you fail to repay the loan, the lender can seize the solar equipment or associated collateral. Mostly, people prefer secured solar loans for the lower interest rates, as the lenders have reduced risk.

Unsecured solar loans don’t require collateral because your creditworthiness and financial history are the deciding factors for providing the loan. However, unsecured solar loans charge higher interest rates because the lenders have increased risk.

You might have many queries about the possibility of switching from a secured loan to an unsecured loan, but your credit score is not high enough to qualify. Choose the right solar loan option by understanding how secured and unsecured loans work, their advantages and disadvantages, different types, and the tax benefits.

What is a Secured Solar Loan? How Does It Work?

A secured solar loan has lower interest rates for financing and installing solar energy systems but requires collateral, where you have to pledge an asset to secure the loan.

Types of collateral used for secured solar loans could be:

• Home or property
• Solar panels and related equipment are themselves collateral
• Valuable assets like vehicles

Collateral Valuation in a secured solar loan involves a professional appraisal of the property asset to determine its current market value. Lenders use the LTV Ratio (Loan-to-Value Ratio) to calculate the amount they are willing to lend, depending on the collateral’s value. For example, if your home is worth $240,000 and the LTV ratio is 80%, you could be eligible to borrow up to $192,000.

Applying for a secured solar loan generally involves several steps:

• Compare various lenders based on their terms and interest rates.
• Application submission, including personal information and financial details.
• Lenders will check your creditworthiness by accessing your credit history and score.
• Appraisal of your collateral asset will be obtained.
• Necessary financial documents like collateral ownership proof must be submitted.
• After approval, the loan amount will be disbursed to proceed with solar installation.

Repayment terms in a secured solar loan could last 2 to 25 years and have a fixed or variable interest rate. However, regular monthly payments in a secured solar loan include interest and principal.

A secured solar loan might be tax-deductible if the collateral property is your primary or secondary residence. On top of that, you could be eligible for federal and state tax credits for installing solar panels.

Defaulting on a secured solar loan leads lenders to seize the collateral to recover the outstanding loan amount. And, this affects your credit score, making it difficult for future loan availability.

Advantages of Secured Solar Loans

You can make well-planned decisions with the various advantages of secured solar loans. Here are the major benefits of secured loans that include — lower interest rates, higher loan amounts, flexible terms, and building your credit score.

• Lower Interest Rates

Secured solar loans come with lower interest, one of the most significant advantages. It is because secured loans require collateral and lenders have reduced risk, allowing them to provide you with favorable interest rates. It is advantageous for you as the monthly payments are lower and the overall interest paid is lesser, making secured solar loans the best choice financially.

• Higher Loan Amounts

You can always access higher loan amounts with secured solar loans because the loan is backed by collateral, and lenders would extend lump sum money. It is advantageous to you looking to finance huge expenses like — home renovations, education, or major purchases.

• Flexible Terms

Lenders offer various repayment options, and their flexible terms are an added advantage of secured solar loans. Repayment options include more extended repayment periods so that you manage your finances appropriately. Also, these flexible terms provide options for choosing the most suitable loan structure according to your budget and financial situation. Sometimes you could adjust payment schedules for your convenience or if the circumstances change you can refinance the loan for further financial security.

• Building Your Credit Score

By making timely payments, a secured solar loan builds your credit score. When you have a positive payment history, you have an improved credit score, further proving your creditworthiness. Having a higher credit score opens the door to future loan opportunities, lower interest rates, and capacity in the future.

Disadvantages of Secured Solar Loans

Although secured solar loans have advantages and serve as an attractive solar financing option with low interest rates, they come with a few drawbacks that you must consider. Here are the disadvantages of secured solar loans that include — losing collateral, longer approval processes, additional costs, and credit impact.

• Risk of Losing Collateral

It is mandatory to pledge an asset in the secured solar loans and this can be a critical disadvantage, where you have the risk of losing collateral, and sometimes solar panels themselves serve as collateral. If you are not able to repay and default on the loan, the lender seizes the collateral to recover the loss. This point needs to be considered if you are already facing financial challenges or are uncertain about future income stability.

• Longer Approval Process

You might experience a delay due to a longer approval process in secured solar loans compared to unsecured solar loans. Lenders take time to evaluate the value of collateral, getting appraisals and additional documentation. Further, the loan disbursement process can delay the solar system installation.

• Additional Costs

Although secured solar loans offer lower interest rates, there are additional costs that you must be aware of. These costs include — appraisal fees, closing costs, and other administrative fees. Furthermore, if the loan is tied to a HELOC (Home Equity Line of Credit), you might face ongoing costs associated with maintaining that credit line.

• Credit Impact

If you miss any payments or default on the loan, it will severely damage your credit score and because secured loans are usually larger amounts, the risks are higher. Having a secured loan on your credit report influences your creditworthiness, and a lower credit score affects future loan opportunities and leads to higher interest rates on other loans.

Types of Secured Solar Loans

Secured solar loans are a great way to finance solar energy systems while leveraging the equity that people have (Home and other assets). You must understand the different types of secured solar loans to choose the suitable option according to your present financial situation.

Here are the different types of secured solar loans where each type has its unique workings, benefits, and drawbacks.

Home Equity Loans

You can borrow against the equity built into your property and generally, these loans provide lump sum amounts where repayment terms and interest rates are fixed.

Working:

• A percentage of your home’s equity can be borrowed, calculated by the difference between your home’s CMV (current market value) and the outstanding mortgage balance.

Benefits:

• Predictable monthly payments with fixed interest rates.
• Interest paid is tax-deductible, as you use it for home improvements, including solar installations.

Drawbacks:

• If payments are missed, there is a risk of asset foreclosure.
• These loans mainly come with higher closing costs.

HELOC (Home Equity Line of Credit)

It might seem similar to the home equity loan, but the HELOC operates more like a credit card, as you can borrow up to a specific limit against your home equity.

Working:

• You can take out funds during a draw period.
• The draw period usually ranges from 5 to 10 years.
• Pay only on the interest for the loan amount received borrowed.
• After the draw period, you enter the loan repayment phase.

Benefits:

• You will have the flexibility of accessing the funds required, hence this loan is a great option for ongoing solar project costs.
• During the draw period, you will have lower payments as they are only the interest amounts since they are often interest-only.

Drawbacks:

• You might experience an increase in interest rates.
• Having possibilities of overspending: The ease of access to funds can lead to borrowing more than necessary.

PACE (Property Assessed Clean Energy) Financing

Allowing you to finance efficient energy upgrades, PACE Financing is one of the unique programs that include solar systems, through property taxes.

Working:

• You can repay the loan through an assessment that would be added to your property tax bill for 10–20 years.

Benefits:

• Solar system installations can be carried out without any initial payment.
• If you sell your house, the debt is transferable and the new owner will take over the PACE loan.

Drawbacks:

• You might experience higher interest rates than traditional loans.
• There might be a negative impact on the sale because some buyers might be scared of taking on PACE debt.

FHA Loans:

Being government-backed, you can use the FHA loans to purchase a home or refinance, which includes the addition of solar systems.

Working:

• If you have a low or moderate income, you can pay a lower down payment.

Benefits:

• Even if you have low credit scores, FHA loans are much lenient and easygoing.

Drawbacks:

• You must pay for mortgage insurance, and this could increase the overall costs.
• There are limitations on how much amount you can borrow in this loan.

Cash-Out Refinance Loan:

A cash-out refinance loan option involves getting a new interest rate or replacing your mortgage loan with a new one without changing the loan balance. In simpler terms, your existing home loan is replaced with a new larger loan, and the difference between the two loans is determined by the amount of cash you withdraw from the overall investment in your home.

Working:

• You can replace your current mortgage with a new and larger mortgage and you can use the extra cash for solar-related works to be done.
• Based on your creditworthiness, property type, and your current mortgage, the cash-out refinance lenders allow you to qualify for 80% to 85% of your property value.

Benefits:

• Interest rates are lower compared to credit cards and personal loans.
• Monthly principal and interest rates are the same, thereby making your payment predictable.

Drawbacks:

• Overall debt increases by taking larger loan amounts.
• Higher chances of losing your home ((which is used as collateral for cash-out refinance), if the loans are not paid on time.

What is an Unsecured Loan? How Does It Work?

An Unsecured loan doesn’t require any collateral, and the lender evaluates the borrower’s credit score. For example, personal loans, student loans, and credit cards are classified under unsecured loans.

Unlike Secured loans, they have higher interest rates due to increased risk for lenders without asking for any collateral from the borrower.

The borrower’s creditworthiness plays an important role in obtaining an unsecured loan. This is because there isn’t any collateral to back the loan for the lender by seizing the borrower’s property if they fail to repay the loans on time.

These are the main steps involved in applying for an unsecured loan:

1. Reviewing your credit score.
2. Calculate your budget to find out if you can manage all expenses comfortably with your current income.
3. Research different lenders and evaluate prequalification to assess the loan offers without affecting your credit score.
4. Gather the required documents such as tax returns or W-2s.
5. Submit a formal application either online or offline and wait for official approval.

The borrower’s credit is evaluated based on the 5 C’s of credits such as Character, Capacity, Capital, Conditions, and Collateral.

Repayment terms for unsecured loans are fixed in monthly installments for two to seven years and are non-tax deductible. But there are a few exceptions if you use these loans for mortgages, Higher education expenses, and Business purposes.

Most often, the unsecured loans are approved within a few minutes, whereas several lenders offer same-day approvals. However, the process might take longer if you are asked to submit additional documents and undergo a hard credit check to evaluate your creditworthiness.

If any one of the unsecured loans defaults, there are severe consequences which include degrading your credit score, and the lender taking you to court by placing a lien on your asset such as your home.

Advantages of Unsecured Loans

Here are the main benefits of preferring Unsecured loans:

• No collateral: Borrowers don’t need any valuable assets such as houses, cars, etc. to be eligible for a loan. This means that they won’t have any risk of losing their property if they default on any loan.
• Faster Application Process: The application process gets completed on the same day with a less complicated process.
• Flexibility: You can use unsecured loans for your personal uses such as unexpected medical bills, home development projects, and travel, thereby having higher flexibility to allow borrowers to take care of their financial requirements. This eliminates the restrictions on how the funds should be used.

Disadvantages of Unsecured Loans

These are the main drawbacks you should consider while opting for unsecured solar loans:

• Higher interest rate: In comparison to secured loans, the interest rates are higher, which is compensation by the lenders for taking more risk to provide the loan by not having the option to ask for any collateral. Also, the repayment period could be longer which forces you to pay more interest.
• Lower loan amounts: The higher risks involved in unsecured loans make the lenders offer lower amounts to limit the borrower’s default.
• Requires strong credit score: Borrowers not have a strong credit score face huge challenges in the loan approval process, with excess interest rates.

How to Choose the Right Loan Option?

These are the different factors one should consider while choosing the perfect solar loan option:

1. Financial Goals: In determining the appropriate loan options, financial goals play an important role in setting targets on how you should save and spend money.

2. Risk tolerance: Risk tolerance means your preparedness and capacity to accept financial risks to earn profitable rewards, which are influenced by your attitude, financial goals, and market conditions. Evaluating your risk tolerance helps to opt for a loan that matches your safety levels considering the possibility of financial increases or decreases.

3. Credit score: It is essential to improve your credit score before applying for any loan by satisfying the minimum FICO score of 670 or a VantageScore of 660. Although you might be eligible to claim a loan despite a low credit score, the higher rates make the monthly payments much more expensive.

4. Loan terms: Basically, the terms and conditions that exist while borrowing money are known as loan terms which include the repayment period, interest rate, charges related to penalty fees, and any other specific conditions. It is mandatory to review the rules and regulations before taking out any loans.

5. Consultation: It is recommended to consult a financial advisor who can guide various loan options and assist in searching for the best loan services that work well with your financial goals and risk tolerance.

Can I switch from a secured loan to an unsecured loan later?

Switching from a secured to an unsecured loan is rarely performed due to its varying structures. However, the transition could be possible through refinancing options to enhance the borrower’s creditworthiness or the preference for better loan repayment terms.

Is a personal loan secured or unsecured?

A personal loan can be secured and unsecured based on the borrower’s and lender’s choice of security in the following ways:

• Secured personal loans require your collateral such as a car, house, savings account, or other assets to become eligible for a loan regardless of a low credit score. The lender has the right to seize the collateral if you fail to repay loans on time.
• Unsecured personal loans don’t require any collateral, but you require a strong credit score and solid finances to get the best offer. The lender’s increased risks pose higher interest rates since borrowers don’t have any threat of losing their assets.

Are there any tax benefits for using secured or unsecured loans for solar financing?

Yes, There are tax benefits for using secured or unsecured loans for solar financing listed below:

1. Net metering allows you to sell excess electricity back into the grid.

2.  Federal solar tax credit reduces 30% of the overall cost of your solar system.

3. Solar incentive programs offer incentives for residents with low income based on the local and state incentive programs. Also, there is an alternative to qualify for utility company incentives if you don’t satisfy the minimum requirements to claim low-income residents’ incentives.

What happens to my secured loan if I sell my home before the loan is paid off?

Suppose you sell your home before paying off secured loans, there are possibilities of facing several complications such as paying off your remaining loan balance as closing costs, prepayment penalties, negative equity (known as underwater mortgage), and transfer of the mortgage.

What should I do if my credit score is not high enough for an unsecured loan?

If your credit score isn’t high enough to qualify for an unsecured loan, you need to follow important strategies such as improving your credit score and opting for a secured loan that requires collateral. Furthermore, you can look for a co-signer with a high credit score to increase your chances for loan approval.

It is recommended to find alternative lenders who can provide loans even if your credit score is low. Finally, you can use credit cards for your financial needs by considering the interest rates and ability to repay the dues on time, so that you can gradually increase your credit score and maintain a good credit history.