A geothermal exchange heat pump, also known as a ground source heat pump, is a heat pump that uses the Earth as either a heat source, when operating in heating mode, or a heat sink when operating in cooling mode. All geothermal heat pumps are characterized by an external loop containing water or a water/antifreeze mixture (propylene glycol, denatured alcohol or methanol), and a much smaller internal loop containing a refrigerant. Both loops pass through the heat exchanger. Air source heat pumps use the same principle but extract the heat from the air, rather than the ground. As such their installation is much simpler and cheaper.

There are three categories of geothermal heat pumps based on the type of external loop:

• open loop system,
• closed loop vertical system,
• and closed loop horizontal system.

In an open loop system the thermal transfer fluid (water) does not return and is a 'once through' type system. The open loop system draws water from a well or lake, passes it through a heat exchanger in the building, and then discharges it. The water can be discharged to a stream or lake, or injected into a second well.

The pipe in vertical closed loop system uses a single well (or borehole) with the fluid in the pipe constantly re circulated to and from the well. If a borehole is used, it is commonly filled with a bentonite grout surrounding the pipe to provide a good thermal connection to the surrounding soil or rock.

The horizontal closed loop is placed below the frostline (1 to 2 m) underground. In a horizontal closed loop system the pipe is often laid out as a spiral, colloquially known as a "slinky", to increase the contact area per length. A typical traditional 2,000 sq. ft. (185.8 m²) residence will require four tons oil equivalent (14.06 kilowatts) of heating capacity, while a well insulated modern residence of equal size should typically consume no more than 1 ton. The amount of vertical or horizontal loop required for each ton of capacity is a function of the soil formation thermal conductivity and deep earth temperature, and also depends on the balance between the amount of heat rejected to and absorbed from the ground during the course of the year. A rough approximation of the soil temperature is the average daily temperature for the region. The heat in the soil is from the sun.

Geothermal heat pumps are also used in non-residential buildings, but the variety of loads and load patterns in these applications make it difficult to specify rules of thumb for capacity per unit of building area, or quantity of heat exchanger required per unit of heat pump capacity. In commercial applications a field of bore holes is drilled. Bore holes are spaced 15-20 feet apart and generally at 150-200 feet deep per ton of cooling. During the cooling season, the local temperature rise in the bore field is influenced most by the moisture travel in the soil. Reliable heat transfer models have been developed through sample bore holes as well as other tests.

Heat pumps are especially well matched to under floor heating systems, rather than wall mounted radiators, and so are ideal for use in open plan offices. Using large surfaces such as floors, as opposed to radiators, distributes the heat more uniformly and allows for a lower temperature heat transfer fluid.

The Earth below the frost line remains at a relatively constant temperature year round, usually between 7-21 degrees Celsius (45-70 degrees Fahrenheit) depending on geographical location. Because this temperature remains constant, geothermal heat pumps perform with far greater efficiency and in a far larger range of extreme temperatures than conventional air conditioners and furnaces.

To understand how a heat pump can heat during the winter and cool during the summer, let us consider each mode:

Heating mode
In the heating mode, the external fluid is pumped from the well at 8-16 degrees Celsius and passes through the heat exchange unit. Within the heat exchanger the refrigerant is allowed to expand and change state into a gas, which absorbs heat (heat of vaporization) from the external fluid, thereby cooling the external fluid. Meanwhile the refrigerant is pumped to the compressor where it is pressurized thereby becoming superheated. The 'hot gas' is the most useful phase of the refrigerant as it releases the heat and warms the air of the house. At the same time, the refrigerant loses heat to the air and changes phase back to a liquid. The external loop again provides the heat necessary to change the refrigerant back into a gas thereby cooling the external fluid. The external fluid absorbs heat from the soil and the process is repeated. Note the external fluid only changes temperature while the internal refrigerant changes both temperature and phase. There are some residential heat pumps that use refrigerant in the external loop.

Cooling mode
The cooling cycle is very similar except a valve on the internal refrigerant loop reverses the direction of flow. Now the compressed refrigerant coming from the compressor heats the external fluid, before passing through the evaporator where it vaporizes taking up heat from the air in the house. The heated external fluid is pumped into the ground where it is cooled and re circulated. Alternatively, the superheated refrigerant may pass through a second heat exchanger allowing the water heater to absorb the waste heat. This means that in summer, the the heat pump provides air conditioning and the hot water. The heat is being pumped from the air in the house to the water in the water heater.