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Driving down the cost of heat pump installations will increase their adoption. Full stop. In past issues, we’ve talked about some of the cost drivers in heat pump installations, and tactics that creative homeowners use to try saving money on their projects. In the toolbox of options to decrease heat pump costs, incentives from governments, utilities, and other providers are one incredible tool to make them an affordable choice. In many cases, layering incentives from different providers makes a new heat pump a less expensive option up front than a new gas furnace and traditional air conditioner.

To write this issue, I teamed up with Dasha Cherepennikova, who previously co-founded a startup focused on incentives for residential energy efficiency. Dasha brings deep experience collaborating with incentives providers, policymakers, contractors, and equipment distributors across the country.

Stacked Incentives are powerful

Let’s take an example case - a new heat pump installation in Redwood City, California. The median cost for a heat pump in California is around $19,000. At the time of publication, most homeowners would be eligible for a $1,000 incentive from the statewide program TECH Clean California. Then they could take advantage of a $500 building electrification rebate from Redwood City, a $2,000 federal tax credit, and a $2,500 rebate from their local utility, Peninsula Clean Energy. That would bring their total down to $13,000, of which they could finance $10,000 through Peninsula Clean Energy at 0% interest, paid back over 5 years on their utility bill. That theoretically makes the $19,000 system just $3,000 out of pocket. And if they were to prioritize value over brand names when choosing their contractor as we’ve previously discussed, it would be very achievable to install a new heat pump for $0 out of pocket.

This example is one of the more lucrative ones in the country, as not every location has so many active incentives available. However, it shows how these incentives can be leveraged by homeowners to make heat pump purchases an easy choice.

Types of Incentives

Broadly speaking, incentives fall into three main categories: tax credits, rebates, and low interest rate financing. Any individual project or household may be eligible for different combinations of incentives, or none at all. The Inflation Reduction Act is a landmark investment into energy efficiency upgrades at the federal level. Funding for other incentives comes from a large variety of sources, including utilities themselves, cap and trade programs (such as Washington’s Climate Commitment Act), state and city budgets, the EPA’s Greenhouse Gas Reduction Fund, and other sources.

Tax Credits

Tax credits can come from both the state and federal level. At the state level, some states have chosen to implement tax breaks - either by reducing sales tax on heat pumps or explicitly giving a tax credit (for example, Colorado). At the federal level, the Energy Efficient Home Improvement Credit, lovingly known as 25C, provides a tax credit of 30% of certain qualified expenses, with a maximum of $2,000 per year for qualified heat pumps. 

Rebates 

Rebates directly reduce the cost of the heat pump purchase, either immediately at the time of sale or as a reimbursement after the fact. Unlike the fairly centralized world of tax credits, the rebate landscape is hyperlocal and fragmented. A specific project could qualify for rebates from the utility, city, state, and federal government, as we discussed in our earlier example.

Financing

Many households can’t afford to buy a heat pump outright, and will require financing in order to bridge the gap. Heat pump specific financing is still a relatively nascent market, unlike the well developed solar financing market. A patchwork of financing options is starting to emerge, from low interest rate loans backed by green banks to on-bill repayment programs through utilities themselves. With the recent grant awards from the EPA’s Greenhouse Gas Reduction Fund, and the demonstrated success of entities such as the Connecticut Green Bank, this is an area that is likely to evolve quickly and one we are excited to see come to fruition. 

There’s always a catch

Eligibility for tax credits is murky

It’s always recommended to seek advice from a licensed tax professional, but it’s important to note that tax credits only apply to taxes you owe Uncle Sam - they are not like deductions that reduce taxable income. This means that if you have no tax liability, like nearly half of Americans, then you do not benefit from this tax credit.

The 25C tax credit only applies to equipment that “must meet or exceed the highest efficiency tier (not including any advanced tier) established by the Consortium for Energy Efficiency (CEE)” (IRS guidance).

In simple terms, this means that not every heat pump is technically eligible for the tax credit. However, many times they are still marketed as such. In practice, few contractors and homeowners check the CEE tool for eligibility, and it is unclear how the IRS is going to audit this. Even with the tool, eligibility can be confusing as even heat pumps from the same product line can have different rebate eligibilities.

Funds aren’t immediate

Another challenge is that the tax credit does not reduce the price at install - homeowners still need to pay the upfront cost and claim the tax credit separately (in contrast, car dealerships can give the EV tax credit up front to consumers). Awareness of these tax credits varies widely, some contractors incorporate tax credits into their marketing materials and sales pitches, while others make no mention. 

Similarly with rebates, most programs have a lag in payout between when a project is complete and funds are disbursed. The homeowner, contractor or another third party has to front the money.

Many rebate programs strongly encourage, or sometimes require, the contractor to give the discount upfront to the consumer. This is great for consumers, but starts to create an accounts receivable problem for contractors.

Most home services contractors are a very cashflow lumpy and cash intensive business, so anything that further complicates cashflow is undesirable. Meanwhile, many consumers have distrust in paying the money up front and waiting for the rebate. 

Rebates are a fragmented patchwork

Many states have their own rebate programs, or have required utilities within their state to roll out incentives for energy efficiency. The result is a patchwork of different rebate programs that each have different nuances that determine eligibility - such as minimum efficiency ratings, consumer income limitations, or existing equipment being replaced. Some programs even restrict incentives to just one brand of equipment, such as Seattle’s Clean Heat program where only Mitsubishi products are eligible.

Inconsistent and onerous requirements

Sometimes, rebate program requirements extend to the installation itself - for example, programs that target replacing gas furnaces with heat pumps can have wildly different interpretations of “decommissioning” the old gas appliance. Some programs allow the air handler of the old furnace be kept but the gas line be capped, while others require a full equipment replacement.

In addition, some rebates require steps and costs that the installation would not otherwise incur, such as getting an independent “Performance Tested Comfort Systems” (PTCS) test.

Regardless of program, managing rebate submissions can create a paperwork burden. Contractors need to manage photo and written documentation about the installation and customer and fill out sometimes long and confusing forms. These can drive the need for additional administrative staff - and as discussed in our recent pricing transparency article, this overhead is then passed on to customers through increased costs.

Often, these requirements will dissuade contractors from participating in the rebate program entirely, opting instead to simply not tell their customers about the rebate or offering a small discount. The devil is in the details and both consumers and contractors need to read the fine print to ensure that a rebate is the best way forward.

Will the well run dry?

Another key challenge with rebate programs is the money itself. Is the rebate large enough to make a dent in consumer demand? What is the overall budget for a program and how do contractors and consumers have visibility?

Multiple high profile rebate programs, especially in California, have had rocky rollouts with budgets drying up unexpectedly. Predictable and consistent funding is key for trust. A rebate that goes away feels ‘bait and switch’ to the consumer, and consumers frequently blame the contractor. As a result, many contractors have been burned by previous rebate programs that suddenly ran out of money and are reluctant to participate in new rebate endeavors. Anecdotally, one contractor resorted to funding the difference out of their own pocket to maintain their reputation.

Being able to ‘reserve’ funds ahead of moving forward with the project is a mechanism to reduce uncertainty, but not all programs allow this (and many of the ones that do have an opaque process for getting in the queue). Some programs have started to publish publicly available ‘funds remaining’ and we’d love to see that become the best practice across the board.

There’s confusion around Inflation Reduction Act heat pump rebates

At the federal level, the Inflation Reduction Act authorized $8.8 billion in rebates for residential energy efficiency projects. The public narrative around the IRA is that everyone has an “electric bank account” to spend, when in reality a very small portion of US households will benefit. For example, the IRA HEEHRA rebates have a budget of $4.4 billion, with a household limit of $8,000 per heat pump.

While this sounds like a big number, it might not actually translate to that many systems installed. Assuming the maximum rebate amount is paid out per project and accounting for administrative expenses, that covers 440,000 projects over the next 6 years, or less than 1% of the entire US housing stock.

In addition, these rebates get passed to states for implementation and distribution - states have some leeway to add requirements for eligible projects, and only 7 states have actually started passing out funds. Most have strict requirements on eligibility, limiting these rebates toward disadvantaged or low-to-medium income households.

True costs of financing can be hidden

Key challenges with financing programs will be consumer awareness and contractor trust, on top of smooth loan application and approval processes. With the majority of heating and cooling projects being done on an unplanned basis, most consumers have not done proactive research on financing options and are also under a time crunch to move forward.

Meanwhile, contractors are sensitive to promoting financing offerings when the approval rates are unknown. If a contractor does already offer financing, either through a local partner or through a provider such as Mosaic or Goodleap, these tend to be very sticky. Contractors want to stick with offerings where they know they will get paid quickly (any delay in getting paid is a direct cash flow problem).

Unfortunately, existing financing options are not ideal. Under current economic conditions, consumers face high interest rates ranging from 10% to 25% on these types of loans. Contractors can offer “0% APR” but in return they are slammed with high merchant fees to make-up for the promotional interest rate. In most cases to offset the merchant fees, contractors raise the overall cost of the installation - pro tip, if you ever see ‘cash discount’ it means the quote includes this financing padding.

In the end, the consumer pays significantly more for the installation, and the consumer reviews on leading loan providers trend towards scathing. 

Going forward

Incentives are a powerful lever in driving heat pump adoption, but there are still challenges in how they are administered, trust and adoption by contractors, and the experience for the end customers. Here are a few ideas that might help. 

1. Streamline the qualification requirements for heat pump equipment eligibility for rebates to something simple like “Heat pump systems with variable speed/inverter outdoor units”. This would reduce the administrative burden and confusion around compliance.

2. Could we have a “Common Application” for incentives? A standardized portal for rebate applications that aggregates different jurisdictions? Many times, the same information is necessary for multiple rebate applications

3. Shift risk of changing rebate program guidelines and budgets away from the contractors and end consumers to a different place. Could some sort of “insurance underwriting” for incentives help both parties feel more confident?

4. Aggregating and comparing heat pump price data from before and after incentives went into effect will show if they actually lower total out of pocket costs for consumers on average

5. If the town you live in or utility that provides your electricity don’t already offer rebates, petition them to consider offering heat pump HVAC rebates

Current incentive programs are a great start, and are already making a positive impact on heat pump adoption. However, bad outcomes with these early incentives could stifle the rate of progress. These programs inherently blend needs of multiple stakeholders and politics, and making this process better isn’t going to be solved by a single party. But efforts from policymakers, community groups, startups, and loud customers help us move the needle toward a world where every HVAC system is a heat pump.

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