Be The Change

Welcome to Week 62 of Be the Change!

Happy New Year! It's been a few weeks' since I've written, but I'm back with an essay about an unsavory practice in the residential solar sector that needs to be exposed and dealt with.

I hope you enjoy and share with friends!

- Andy

Residential Clean Lending's Dirty Secret

Residential Clean Lending's Dirty Secret
In August of 2021, just as Capital Good Fund was launching our solar lending pilot, I wrote an article, Say It Ain't So, Solar Lenders!about some unsavory practices in the industry. Since then, several things of note have happened.

First, Capital Good Fund has successfully completed our pilot: we've now originated 81 DoubleGreen Solar loans for $3.57 million to low- and moderate-income families in Rhode Island, Massachusetts, and Texas. Having perfected the mechanics of solar lending--installer relationship management, reviewing scopes of work, managing payouts, etc.--we're ready to massively scale the program. And, in fact, in the next few weeks I will have an exciting update about an initiative that will result in us financing billions--yes with a "B"--in solar installations over the next ten years.

Second, the Inflation Reduction Act (IRA) was signed into law, establishing hundreds of billions of dollars in incentives for solar panels, battery systems, heat pumps, green hydrogen, energy-efficiency retrofits, electric vehicles, and more. (I write about the IRA here.)

Third, I have come to an even clearer understanding of how the large residential solar lenders operate. A quick summary is as follows. The majority of volume comes from so-called financial technology (fintech) lenders that boast very sleek platforms that have revolutionized the residential solar industry: it's never been easier for installers to take care of the financing aspect of the transaction. This is crucial, because a typical solar system can easily cost $30,000; and solars pay for itself fairly quickly, most people cannot afford to buy 30 years of energy up-front.

The issue for a solar lender is that it must charge a rate that is attractive to its investors, profitable to it, and yet low enough so that the customer realizes day-one savings. That turns out to be a challenging proposition. Imagine the following scenario. A customer needs a $35,000 system to offset her $200 / month utility bill. With a 25-year loan term, the highest APR she can be charged and still realize savings--that is, pay less on the loan than she was paying on electricity--is just 4.75% APR, a rate that's considered low for a mortgage, let alone a personal loan.

These days, the fintechs have to deliver a return of about 7% to their creditors, so clearly a 4.75% APR doesn't work: it can't even cover defaults or the lender's operating costs. So how do they make it work? The answer is often hidden dealer fees. In the above example, the typical solar lender wouldn't be financing $35,000, but rather that amount multiplied by a dealer fee--which, in this interest rate environment, can be as high as 40%. But here's the thing: that 40% is added to the system price by the installer, and the customer has no idea. So the customer is told that the system costs $49,000 ($35,000 X 1.4), not $35,000, and the fee is never disclosed.

The lender then uses this fees to lower the interest rate, so that the monthly payment is still under $200. In this case, an interest rate of 1.6% comes to a $198.28 monthly payment. Sounds great, right? Well, in a way, yes: the customer does save money on their bill on day one. But because they don't know about the hidden fee, if they pay off the loan early--when they sell the house, say, or with the 30% solar tax credit--their effective borrowing cost goes through the roof.

Think of it this way. If you pay $49,000 for a $35,000 solar system in order to lower your monthly payment, only to then unexpectedly sell the house two years later, you've now paid $15,000 you didn't have to. At some point, the lower monthly payment makes up for the closing fee, but it's usually at least 7 years. And because the customer is in the dark, she can't factor that into her decision.

The way the fintechs make money, then, is that the average solar loan is only outstanding for five to seven years; the faster they are paid off, the higher the return to the lender and the worse the economic return to the homeowner. (A $35,000 loan at 2.99% interest and a 40% dealer fee equates to an APR to the borrower of 6.27%; if the loan is paid off in five years, the investor's yield is over 7%.)

Now you may ask whether this is legal. The answer is, I'm not sure; it sure seems to violate the Truth in Lending Act (TILA) because it hides the true cost of the loan. And the Consumer Financial Protection Bureau (CFPB) just sued one of the largest subprime auto lenders in America, Credit Acceptance Corp, for practices that seem awfully similar to the dealer fee model. From CFPB's press release:

Since 2014, Credit Acceptance’s loan agreements nationwide have said that consumers would pay interest at an average 22% APR. However, the true cost of credit offered is far higher than what borrowers are told. This is because Credit Acceptance’s business model pushes dealers to manipulate the prices of vehicles sold to Credit Acceptance borrowers, based on borrowers’ projected performance. This increases the principal balance of the loans. By hiding the true cost of the credit in inflated principal balancesCredit Acceptance evades state interest rate caps and deprives consumers of the ability to make informed decisions, to compare financing options, or to avoid high interest charges.

There are some differences, to be sure. Not all the fintechs change the dealer fee based on projected performance, and the price of a solar system can vary greatly, whereas the price of a car is based off an MSRP. But the similarities are stark, and raise a serious question: Should this practice be reported to the CFPB? Even though the fintechs have lent billions of dollars to support residential solar, battery, and energy-efficiency projects, does that outweigh the potential harm to consumers?

And even if the practice is technically legal, it is undoubtedly anti-consumer. Wouldn't it be better to just disclose the fee? I understand why the fintechs don't want to: a 20% - 40% closing fee sounds absurd! But guess what? Capital Good Fund has been charging a 20% fee--we call it a buydown fee, which will make sense in a moment--on our solar loan, and 75% of customers have chosen to pay it.

We offer customers two options. First, they can finance the $35,000 system for $35,000 at 6.99%. We tell them that this option is better if they don't plan to keep the loan for 7 years or more. Or, they can pay a 20% buydown fee, which is rolled into the loan amount (meaning, they are borrowing $42,000; they don't pay the 20% out-of-pocket, rather it's included in the loan amount) and fully disclosed in compliance with TILA. In exchange, we are able to "buy down" their interest rate to 2.49% - 3.49%, which equates to an APR of 4.178% - 5.265%. This is similar to "points" on a mortgage, where a fee is added to the principal balance in order to lower the interest rate.

Rather than being upset, the customers appreciate the information, and our loan officers are trained to walk applicants through the options so that they can make the decision that's best for them. Some customers expect to use the 30% tax credit to pay down the loan, or want to go solar but aren't sure how long they'll stay in the home: in these cases, we recommend the higher APR and no fee. Other customers don't qualify for the tax credit or simply prioritize the lowest monthly payment: for them, the buydown makes the most sense.

Sure, I could see the argument that it's easier not to have that conversation, but that's not the point: the fintechs' dirty secret is illegal at worst, and at best it's an ugly practice that, if and when it gets out, will turn off many homeowners from going green at the moment when we most need to scale the sector. And to be clear, I'm not writing this post because I want to take market share away from the fintechs. For one thing, they lend more in an hour than we lend in a month--we cannot match their scale. For another, they lend to higher-income, higher-FICO borrowers that we neither want nor, as a nonprofit, can lend to (at least not exclusively.)

If anything, I am reluctant to write this because I don't want to hurt the sector: my only concern is, as I've said, consumer protection and the legal and reputational harm to the industry. Nor do all fintechs engage in this practice or charge absurdly high fees; and there are myriad banks, credit unions, and others that have equitable and transparent products. Still, my guess is that roughly half of all residential solar systems are financed with hidden dealer fees of at least 20%. The question is what, if anything, will lead to a change?
How are those New Year's Resolutions coming? Enjoy your MLK Day tomorrow!

- Andy