Loan or Debt Financing

Loan or Debt Financing

What is Loan or Debt Financing?

Customers can borrow money directly from banks or other lenders to pay for energy efficiency projects. The customer must then arrange the purchase, installation, and management of equipment by a third-party contractor or in-house staff. Loan financing is offered by many equipment manufacturers, vendors, and contractors as well as third-party banks and lenders. Loan terms and availability may be affected by the creditworthiness of the customer, limitations on debt that can be taken on the balance sheet, or current debts held by the customer.

A loan may be a good fit if your organization...

  • Wants a simple, quick, accessible financing option with minimal contract complexity
  • Is considering working with a manufacturer or contractor that offers loan financing
  • Is relatively credit-worthy and willing to take on equipment performance risk
  • Qualifies for one or more of the various below-market and philanthropic loan options below

To compare loans to other financing options that might be a good fit, answer a few questions about your organization.

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How it Works

The customer arranges loan financing through the manufacturer, vendor, or installer of the efficiency equipment being purchased or, if unavailable, directly with a third-party bank or other lender. Regional and local banks have been the primary drivers of these offerings to date, but larger banks have shown increasing interest in energy efficiency. In addition, project financiers specializing in energy efficiency are increasingly offering commercial loans or other debt products to fund efficiency projects. The customer owns the equipment from day one and pays down the loan over time.

The specific term, interest rate, down payment, and other loan parameters depend on the credit history of the customer, the lender’s perception of payment default or delinquency risk, and in some cases the details of the proposed project. Loans often require a down-payment of 20-25% of the full loan value, and they may be secured by the efficiency equipment (non-recourse debt) and/or by the customer’s mortgage or other assets (recourse debt).

In addition to being used to directly fund efficiency projects, loans are also used to back other financing structures. Energy performance contracts (EPCs), Commercial Property Assessed Clean Energy (CPACE), and On-bill Financing/Repayment (OBF/OBR) are all commonly backed by loans or other debt products.

An Alternative Approach: Below-Market and Philanthropic Loan Programs

For certain organizations, loans may be available with more flexible or favorable terms such as below-market interest rates or greater tolerance for poor creditworthiness. These programs are typically established by public organizations, foundations, or other private entities for the purpose of serving a specific social need such as greenhouse gas mitigation or community development. They vary widely in program design and target market but typically fall into the following categories:

State and Local Loan Programs

Many state and local governments have established loan programs that specifically target energy efficiency and clean energy projects within their borders. These programs can often provide lower rates and/or more flexible terms than traditional private sector lenders, and they may operate in communities where loans are less accessible. They include “internal” loan programs that fund only projects in government facilities, as well as “external” programs that serve the broader community, including private sector organizations. One of the most prominent examples is the Texas LoanSTAR Revolving Loan Program, which has financed 237 loans totaling over $395M. In total, more than 30 states have established loan programs targeted at energy conservation or renewable energy.

More information on state and local loan programs is available from the Department of Energy Revolving Loan Funds page. You can find specific information about loan programs in your region by searching for “Loan” in the Database of State Incentives for Renewable Energy.

Community Development Financial Institutions

Community Development Financial Institutions (CDFIs) provide loans and other financial services to poor, underserved, or otherwise disadvantaged communities. They include banks, credit unions, loan funds, and venture funds, and they may serve organizations including non-profits, small businesses, real estate companies, affordable housing, and other sectors. Many CDFIs have programs specifically targeting energy efficiency and renewable energy projects, so they may be a good fit for organizations that seek to reduce their energy costs but otherwise have difficulty accessing capital markets at reasonable rates.

More information on energy-related CDFI programs is available from the Opportunity Finance Network and the Council of Development Finance Agencies.

Grants and Program-Related Investments

Foundations, governments, and other funders sometimes issue grants, repayable grants, or program-related investments (PRIs) to fund clean energy and energy efficiency projects in mission-driven organizations. A grant is a direct donation (and is therefore not considered a loan or debt), whereas a repayable grant comes with a requirement that the principal be paid back to the donor. A PRI is a relatively new structure in which the donor issues a loan with an interest rate well below the standard market rate, allowing the donor to count the PRI as a charitable donation as long as it meets certain IRS requirements. These options are provided by a variety of local, regional, and national organizations, and each program typically has its own target market and overarching goals.

Notable grantmaking organizations focused on energy efficiency include the Jessie Ball duPont Fund, the High Meadows Fund, and the Department of Energy.

U.S. Small Business Administration (SBA) Loan Programs

The U.S. Small Business Administration (SBA) was created in 1953 as an independent agency of the federal government to aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise, and to maintain and strengthen the overall economy of our nation. As part of their services, the SBA offers numerous government guaranteed loan programs that can be used to improve the energy efficiency of commercial buildings. By providing government guarantees to loans made by commercial lenders, SBA helps to enhance small business credit by guaranteeing 50%-85% of an eligible bank loan. SBA loan programs that can be used to finance building energy efficiency projects include:

  • SBA Advantage (7a): SBA’s most common and flexible loan program. $5 million maximum loan amount.

  • SBA Grow (504): Designed for financing real estate projects and equipment purchases. If building owner can reduce energy use by 10% or offset energy use by 10% with renewables, they can increase their maximum loan debenture from $5 million to $5.5 million.

  • SBA Express: 36-hour application review and response from SBA. $350,000 maximum loan amount.

  • SBA Microloan: Typically up to $50,000 in loan dollars; however, some lending institutions can go up to $350,000. 

Advantages and Disadvantages

WIDELY AVAILABLE AND QUICK TO CLOSE
Manufacturers, vendors, and installers frequently offer loan financing as part of the equipment sale, making it easy to find financing and close the deal quickly. The potential capital available from banks and lenders in the market is very significant.
SIMPLE STRUCTURE
Loans are simple documents that require a low level of effort to execute and administer, and they are well understood by most finance teams.
ENTERPRISE-SCALE FINANCING
Loans can be a good solution for portfolio-wide initiatives. Most lenders are able to finance projects across many facilities simultaneously, or to provide a large loan that can be allocated across multiple projects internally.
REPAYMENT FLEXIBILITY
Many loans are flexible in how quickly they must be repaid, allowing the customer to adjust payments to changing circumstances.
CREDITWORTHINESS
Creditworthiness can have a large impact on availability of financing and the rates offered. While loans are secured by the equipment and/or other customer assets, they do not provide additional security for lenders to the extent that some other financing structures do (e.g. PACE, On-bill). That said, customers with good credit and/or existing relationships with banks or other lenders may be able to obtain low interest rates.
DEBT LIMITATIONS
Many buildings already have higher debt levels than lenders are comfortable with, and existing mortgages may prevent additional lending. In addition, many organizations have legal or governance restrictions on the amount of debt they can take on their balance sheet.
DOWN-PAYMENT OFTEN REQUIRED
Loans often require a down-payment of 20-25%, which may prevent projects from being cash flow positive from day one.
NO SPECIALIZED BENEFITS
The straightforward structure of loans means that they do not provide the benefits of some of the more specialized financing options, such as performance guarantees (e.g. ESAs, EPCs) or automatic transferability (e.g. CPACE).

State of the Market

Loans have existed since nearly the beginning of recorded civilization, with the first known loans of grain made to farmers and traders in Mesopotamia nearly 4,000 years ago. Loans are used to finance a variety of assets, and they are one of the most common methods to finance energy efficiency measures. Due to the large size of the lending industry and the fact that many lenders do not track which of their loans qualify as efficiency equipment, it is difficult to estimate the size of the energy efficiency lending market. However, the market is very large, in part because leases are commonly used to provide underlying financing for energy performance contracts (EPCs) and other structures. Within the Better Buildings program, the Financial Allies completed over $1B in energy efficiency loans from 2012 to 2016. Loans and debt will likely continue to play a major role in energy efficiency financing for years to come.

Learn More about Loans

ENERGY STAR® — Building Upgrade Manual Ch. 4

Loans At-A-Glance
The following table will give you an at-a-glance summary of a typical loan, including a basic description, contract structure, tax and balance sheet implications, contract terms, and market information. Mouse over the ‘?’ next to each attribute for more information.
    Commercial Loan Below-Market Loan
Basic Attributes Applicable Sectors?Which economic sectors does this option commonly serve? All Common: Affordable Multifamily, Non-profit, Private Universities/Schools/Hospitals
Less common: Government
Uncommon: Commercial & Industrial, Multifamily
Geographic Scope?Is the financing option available throughout the U.S., or limited to certain areas that have the appropriate policies and programs in place? Nationwide Nationwide
Building Ownership?Does this option work well for projects in leased space, owned space, or both? Owned or leased Owned or leased
Typical Project Size?What range of project sizes does this option typically serve? Any Any
 
Contract Structure Contract Complexity?How complex is the financing option from the customer’s perspective, in terms of the size and complexity of the financing contract, the number of parties involved, and other factors? Low Medium
Parties Involved?Which types of organizations are typically involved in executing the financing option? Customer, Lender Customer, Lender
Payment Type?Are customer payments fixed over time or might they be variable based on factors such as energy savings or utility rates? Typically fixed, but sometimes with flexibility for variable payments Fixed
Guaranteed Savings?Is the customer typically guaranteed some amount of savings net of payments on the financing contract? No No
Measurement & Verification?Is measurement and verification (M&V) of project savings typically provided as part of the financing contract? No No
 
Tax & Balance Sheet Budget Source?Do customer payments made on this financing option typically come from an operating budget ("opex") or capital budget ("capex")? Capex Capex
Balance Sheet Treatment?According to industry best practices, does the financing option typically appear as a liability on the customer’s balance sheet, or is it off-balance sheet? On balance sheet On balance sheet
Tax Deductions?Which amounts can a customer typically deduct from its taxes under this financing option? In some cases all payments are deductible, and in other cases only interest and depreciation are deductible. Depreciation, Interest Depreciation, Interest
Equipment Ownership?During the financing term, is the efficiency equipment typically owned by the customer (internal) or by an outside party such as the lender or contractor (external)? Internal Internal
Collateral Source?Which customer assets can the lender use as collateral to secure repayment? Sometimes just equipment (non-recourse loan); sometimes mortgage or other assets in addition to equipment (recourse loan) Equipment
 
Contract Terms Typical Duration?How long does a typical financing contract last? Often 3-5 years, but flexible Often 3-5 years, but flexible
Typical Close Time?How long does it typically take to secure financing once you start speaking with providers? Short (1-3 months) Medium (3-9 months)
 
Market Attributes Market Size?What is the total cumulative dollar value of projects financed under this option? Very large Very large
Time in Market?How long has this financing option been available in the market? Since ~2000 BCE Since ~2000 BCE