One of the things you should know before buying solar panels is how to calculate solar payback. You can calculate solar payback on the back of a napkin or calculate the net present value using a solar NPV calculator.
How to Calculate Solar Payback
There are two common methods to calculate solar payback:
- Simple payback
- Net Present Value Payback
The “simple payback” method can be done on the back of a napkin. The “simple payback” method tells you the number of years it will take for the solar system to pay for itself.
For example, if your solar panels cost $20,000 and they save you $2,000 per year, the solar panels will pay for themselves in 10 years.
Simple Payback For Solar Panels
On the napkin example above, if $10,000 is the cost of the solar panels and you save $83.33 per month in electricity costs ($1,000 per year), you will have a 10 year payback.1
According to EnergySage, the average consumer solar system has a payback of around 7.5 years.
However, the lifetime payback of solar panels is better because solar panels can last for over 30 years! This means that your solar panels could pay for themselves again and again, many times over.
Indeed, many solar systems are still going strong after 30 years.
The oldest solar panel system in the U.S. is the SEGS system in California’s Mojave desert. The SEGS solar array went live in 1984 and is still chugging along producing electricity today, almost 35 years later!
Using the simple payback method below, you can calculate your solar panel payback very easily.
Put the cost of the solar panels in the numerator.
Put the expected annual electricity savings you expect to receive from your solar panels in the denominator.
Divide the denominator into the numerator and this will give you your simple payback in years.
Solar Net Present Value (NPV) Payback
Unfortunately, the simple payback method does not consider the time value of money, nor does it consider your required rate of return for investments.
The time value of money means is sometimes referred to as “opportunity cost”… It means that dollars received today are worth more than dollars received in the future.
You would prefer to receive $1,000 today because you could invest that money to earn a rate of return or you could earn some interest by putting the money in the bank. According to NerdWallet, even with interest rates are extremely low, you would still earn something on your $1,000.
If you had to choose between putting the $10,000 in the bank for almost no interest, or invest in a $10,000 solar panel system that would pay you $1,000 per year for 10 years – how would you choose?
If you put $10,000 in the bank at 2.35% interest it would become $12,614.74 after 10 years according to Investor.gov’s compound interest calculator… However, your solar panel system might pay for itself by then.
As such, the best way to calculate solar payback is to consider the time value of money, and to do this you would use the net present value or present value payback approach.
A solar net present value calculator factors in the time value of money and your hurdle rate with a method called “discounting“.
Discounting is the opposite of compounding.
Compounding works powerfully to grow money over time and discounting works powerfully in reverse to reduce the value of money that isn’t received until some date in the future.
As such, when calculating solar payback, one should take the time value of money into consideration because it provides a more accurate way to calculate return on investment.
Don't Forget Solar Tax Incentives
When calculating solar payback don’t forget to subtract any government tax incentives that will reduce the up front cost of your solar panels.
The most important one to remember is the solar investment tax credit (ITC)… The ITC started phasing out in 2020. You can read more about the federal solar tax credit phase out here.
The ITC makes all the difference in your return on investment (especially when considering the time value of money – as described above).
Solar makes sense for many residential homes and commercial buildings… Just make sure you calculate the payback and understand the factors that go into commercial solar panels cost.
