Energy costs have soared this year in most parts of the U.S. This means that the payback period for investing in energy-efficient improvements to your home has decreased. If you’ve delayed improvements because of cost, take another look. You may find that a new furnace or energy-efficient windows now make financial sense.

An energy investment’s simple payback period is the amount of time it will take to recover the initial investment in energy savings, dividing initial installed cost by the annual energy cost savings. For example, an energy-saving measure that costs $5,000 and saves $2,500 per year has a simple payback of $5,000 divided by $2,500 or 2 years:

Simple Payback = Cost $5,000/Savings $2,500 (per Year) = 2-year Payback

While simple payback is easy to compute, its weakness is that it fails to factor in the time value of money, inflation, project lifetime or operation and maintenance costs. To take these factors into account, a more detailed life-cycle cost analysis must be performed. Simple payback is useful for making ball-park estimates of how long it will take to recoup an initial investment.

Of course, the more thoroughly you analyze paybacks, the more comfortable you will feel with your decision to move forward with an energy improvement investment. Some utility companies provide powerful energy payback calculators that can be a great help.

Here’s a four-step guide for evaluating opportunities to save on your energy bills by investing in home improvements:

1. Visit the excellent Home Energy Saver website sponsored by the federal Department of Energy. Here you’ll be able to conduct a thorough on-line analysis of your current home energy situation and pin-down specific energy savings opportunities. You may also want to utilize free or low cost home energy audit services offered through utility companies and state or local government agencies.

2. Determine Your Energy Improvement Budget - Using the information gathered above, select the energy improvements with the best paybacks. Get estimates from contractors to do the required work and develop a budget amount that you feel is manageable. Be sure to include a contingency (10%) and to adjust for work you may be able to do yourself.

3. Learn About New Energy Tax Credits - The Energy Policy Act of 2005 (EPACT) provides several attractive tax credits for homeowners considering energy improvements. These range from a $2,000 credit for solar water-heating equipment to a credit of $50 for installing a whole house circulating fan. Taking time to learn about these incentives is well worth it. The savings will further improve your payback period.

Home Energy Efficiency Improvement Tax Credits
Consumers who purchase and install specific products, such as energy-efficient windows, insulation, doors, roofs, and heating and cooling equipment in the home can receive a tax credit of up to $500 beginning in January 2006.

The EPACT also provides a credit equal to 30% of qualifying expenditures for purchase for qualified photovoltaic property and for solar water heating property used exclusively for purposes other than heating swimming pools and hot tubs. The credit shall not exceed $2000.

Improvements must be installed in or on the taxpayer’s principal residence in the United States. Home improvement tax credits apply for improvements made between January 1, 2006 and December 31, 2007.

4. Determine How You Will Finance the Improvements - You have several options as to how you will pay for the improvements:

• cash
• home equity loan or HELOC
• energy efficient mortgage (EEM)
• reverse mortgage
• conventional home improvement loan

Which option makes most sense depends on your particular circumstances.

Personal finance experts make distinction between “good” and “bad” debt. Bad debt is incurred for consumptive purposes such as eating out, electronic gadgetry, etc. that produces little or no long term return for the borrower. Good debt, on the other hand, produces cash flow and/or increases value (e.g. a college degree).

Careful use of debt for investing in energy efficient home improvements clearly is in the good debt category. Not only will your investment be returned through lower monthly energy bills, the value of your home will increase as energy efficiency becomes an increasingly important consideration for buyers.