It's Payback Time

If you’re looking to find out if a given home improvement makes financial sense, there are many different ways to do so.   There’s Net Present Value, Internal Rate of Return, Return On Investment (ROI), and so on.  But the term one hears the most when considering home projects is ‘payback’.   Payback seems simple to understand – the cost of the improvement divided by the savings - but it’s actually a fairly complex concept, and on top of that, it turns out it isn’t always the greatest analysis tool. 

I’ve been thinking about payback recently since we’re thinking about adding a solar thermal hot water system.  Payback does give you some idea of the difference between doing something and not doing it at all, but it doesn’t take into account future variability, such as fluctuating energy costs, changes in usage rates, or inflation.  And what about ongoing maintenance costs, or the resale or salvage value of the improvement at the end of its service life?  In fact, as a Prius driver, I always find the concept of higher resale value a glaring omission in the discussion of whether a hybrid is “worth it” – since a fuel-efficient car should be worth more to the next owner as well, I don’t have to pay for all those batteries by myself.  Although, my F-350 has held its value pretty well too. 

But of course when we discuss payback, what we’re trying to determine is whether it makes sense to spend money in order to save money.  Speaking of saving money, interest rates on savings are currently similar to the rate of increase in energy costs .  Given that, it could be that a home efficiency or renewable energy project is one of the best ways to generate a return.  If you identify an appropriate long-lasting home improvement that should reduce your energy costs, that investment could be better than leaving those dollars in your account generating almost no return; or putting that money in the stock market, which is unpredictable.  Thus, if you assume money held in savings will return a 1% interest rate, and the annual energy savings resulting from the new project are more than 1% of its cost, it might make sense to put that money to work cutting your energy spend.  Of course, if you lose your job, possibly because of your stupid blog posting, you can’t turn your solar hot water heater back into cash.  It’s not a ‘liquid’ asset.

So here’s a simple payback example - install a direct fired instant on propane water heater.  Installed cost: $1500.  Monthly savings vs. electric hot water: $30.  That means an annual savings of $360, or a simple payback of 1500/30 = 50 months, or 4 years and 2 months.  That’s forgetting about any increase in the value of the home, or any maintenance or service costs.  Is it worthwhile?  That’s where payback doesn’t necessarily help you make a decision – it would only be good for comparing option A vs option B. 

What’s all this leading up to?  I did decide to have solar thermal installed on my house, and the simple payback is dubious.  The project, which consists of a super-insulated dual coil water tank in the basement, and collector panels on the roof (and the installation thereof), is costing about $10,000.  We received a $1,000 rebate from the state, and believe we will be eligible for the 30% tax credit on the remaining amount of $9000, leaving us an eventual system cost of approximately $6300.

I project the system will save us about $50 per month in energy costs.   This is an average between summertime savings, where it should heat essentially all of our hot water, and the dark of winter, where it should handle about 10% of the cost, for our family of four.   So in a simple payback scenario, it looks like this: 6300/50= 126 months, or more than 10 years, to break even – just to pay me back in reduced energy bills.  That's really a long time to assume that nothing will change.  However, factors I considered were that during that time, energy costs could well go up, plus, the alternative, the instant-on water heater, arguably a good choice and perhaps wisest financially, will continue to cost me dollars to own after I’ve achieved the payback with the solar thermal system.  The thinking is that after the 10-year mark (it’s projected to have a 25-year service life), I’ll still be generating a return with the solar unit while continuing to pay energy costs with the instant on system.  Plus the solar thermal system may be more likely to add to the resale value of the house. 

So what do you think, did I make the right choice?  Is my payback analysis legit?  It was surprisingly hard to find good payback calculators on the web.  I did find Home Calc from EnergyStar, but couldn’t get it to work for me.  Any other good calculators out there?  Also, I’m working on a posting about the solar hot water install – very interesting stuff.  The installers did tell me they prefer to work on asphalt shingle roofs…

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