You Can Use Your Home Equity to Buy a Heat Pump. Should You?
Home equity can always be used for home improvements. But consider some of the other options before you jump headfirst into buying a heat pump.
- Journalism awards from the Boston Press Photographers Association, the Society of Professional Journalists and Boston University
Getting a heat pump can save you money on energy costs and reduce your home's reliance on fossil fuels, but they can be expensive.
Heat pumps, which many Americans had scarcely heard of just a couple of years ago, are suddenly all the rage.
Demand for the all-electric heating and cooling systems has skyrocketed, and there's a new wave of interest thanks to generous new tax incentives in the Inflation Reduction Act, along with some state mandates to ditch fossil-fueled systems. Consumers are increasingly drawn not only to the climate sustainability benefit of heat pumps, but also the potential energy savings and increased comfort they can provide for a home.
But the systems aren't cheap; they can cost anywhere from $3,000 to $15,000. Leveraging the equity in your home is one way to pay for it; here's what you need to know before you go down that path.
Jump-start your solar journey by exploring Home Equity & HELOC rates from multiple lenders
What is a heat pump?
Think of a heat pump as a sort of air conditioning unit that also provides heat. The heat pump itself is a boxy unit that sits outside, and is connected to wall units throughout your house.
In the winter, a heat pump draws in heat from the air (yes, believe it or not, there is heat in the air even on the coldest days), condenses it and pumps the hot air into your home. In the summer, it does the opposite, functioning basically like a standard air conditioner.
These systems run solely on electricity, making them a more climate-friendly option that does not rely on fossil fuels. And they're a lot more efficient than most traditional types of heating systems.
What is a home equity loan?
A home equity loan is essentially a second mortgage you take out against your home. Let's say your home is worth $500,000, and your primary mortgage is $300,000. That means you have $200,000 in equity available.
A bank would usually be willing to lend to you up to 80% of the home's value. With a home equity loan, that's in the form of a lump sum of cash. You pay that money back over a certain number of years, maybe 10 or 15 (depending on the loan terms), in monthly payments with, usually, a fixed interest rate.
What is a HELOC?
A home equity line of credit serves mostly the same purpose as a home equity loan, but in a different shape.
Instead of taking out a fixed lump sum of cash with a loan, a HELOC acts more like a credit card. A lender would approve a certain limit to the credit line -- let's say $50,000 -- and you would be able to use that money as you go, only paying back, and paying interest on, what you borrow. HELOCs, however, usually have variable interest rates, which means your monthly payment could change over time.
Pros of using a home equity loan or HELOC to finance a heat pump
Home equity can be a great tool for funding a new heat pump system in your home.
"One of the main pros to doing it would be immediate access to the cash," said Keenan Casey, a certified financial planner at Facet Wealth. In other words, using your home equity would allow you to invest in a heat pump a lot faster than, say, saving up the cash.
And there's also a benefit to not tying up significant amounts of cash you might already have saved.
"The beauty is that you're not tapping into possibly other cash that you have on the sidelines, perhaps emergency savings, you're not using that to cover home improvement," said Marianela Collado, a certified financial planner, senior wealth adviser and CEO of Tobias Financial Advisors in Florida.
Plus, using home equity helps you spread the cost of a heat pump system over a longer period of time.
"You're able to make those improvements up front, and then you're paying for those improvements through monthly installments," Collado said.
Home equity advantages:
- You have immediate access to the funds you need
- Home equity loan interest could be deductible from your taxes, because you're using it on home improvements
- You can avoid draining your savings account
- You can stretch out the cost of the heating system
Cons of using a home equity loan or HELOC to finance a heat pump
As with any financial product, there are some drawbacks to borrowing from your home equity.
While the idea of monthly payments -- rather than upfront cost -- can be appealing, you want to make sure that you have enough cash flow to cover that new bill.
"It's nice making all these renovations, but you have to pay that back," Collado said.
And if you can't, suddenly you've got yourself in a very tricky situation.
"You're putting a loan against an asset that you have [that is, your home], so if you're not able to pay that loan, you can lose the asset," Casey said.
Taking out a home equity loan or line of credit is essentially "borrowing against your future," according to Casey. You'll be stuck with a monthly payment for decades, and that could impact your ability to save for retirement or other investments.
"What, if anything, is being sacrificed for this decision?" Casey said.
Home equity downsides:
- Paying back a loan could strain your budget
- Borrowing against your home can be risky
- You might lose the opportunity to make other home improvements
Alternative heat pump financing options
Home equity is certainly not the only way to finance heat pumps. Here are some of the other options you might consider:
Cash purchase
You could, quite simply, stash away money in a high-yield savings account until you've got enough to pay for the system in cash.
"The thought of debt is scary to a lot of people, and they'd rather only do something when they can truly afford it," Collado said.
Plus, you'll avoid signing up for a new monthly loan payment that would have a lasting impact on your budget. And if you change your mind about a heat pump, you can simply divert your savings to something else.
But this might not work for everyone. Especially if you're in a rush to get a heat pump, it's probably not appealing to wait a few years while you save up. "A lot of clients don't like the delayed gratification," Casey said.
Paying in cash would also foreclose that opportunity to deduct home equity loan interest from your taxes.
Benefits
- Avoid taking on new debt
- One-time cost, rather than a monthly payment for years
- Keep resources liquid in case you change your mind
Drawbacks
- Delays the purchase
- No loan interest to deduct from your taxes
Personal loans
Much like a home equity loan, a personal loan would give you really quick access to a large sum of money. "It's a financial instrument that has been invented because people don't like delayed gratification," Casey said.
But that comes at a cost. Personal loan interest rates are steep, usually above 10%, adding a significant price to the money in the long run.
Casey said that might be worth it for some homeowners, if the intangible value of making their home more sustainable, as quickly as possible, justifies the higher cost.
Benefits
- Quick access to the cash you need
- Avoid delay in electrifying your home
Drawbacks
- High interest rates
- Adds to the total project cost in the long run
Credit card
If you've got a credit card with a high enough limit, it could be tempting to use it to pay for your heat pump. But this has some of the same downsides as a personal loan: namely, really high interest rates.
There are, of course, some credit cards that offer an introductory rate of 0% for the first year. In theory, you could put a heat pump on a card, pay it off within the year, and pay no interest.
But most people don't end up pulling that off -- a fact that credit card companies are well aware of. "They're not charitable organizations," Casey said. "They're trying to make money from us."
If you're going to go down this road, be careful. Credit card companies are ultimately out to profit from your mistakes, and you need to be disciplined to avoid that outcome.
Benefits
- Immediate ability to pay for a heat pump
- Opportunity for 0% interest for the first year
Drawbacks
- Some of the highest interest rates
- Risk of falling behind on payments
Financing through the installer
It's not uncommon for heating companies themselves to offer loan products to their customers. They know that the upfront cost is often a barrier to entry, and are willing to help homeowners pay for a system through monthly installments.
Casey said this can be an attractive option, especially because many installers offer 0% interest on these loans. But he cautioned that you still need to be smart about your budget: If you can't honestly handle another monthly payment, then it doesn't matter how low the interest rate is, because it's still going to strain your finances.
And if a supplier loan does have interest, Collado said it may not be tax deductible in the same way that home equity loan interest is.
Benefits
- Potential for 0% interest
- Ease of financing and installation from one provider
Drawbacks
- Monthly payments impact your cash flow
- Interest may not be tax deductible