You are here

Interest rates on the rise?

The Federal Reserve has kept interest rates near zero for
over two years, but the second phase of easing is scheduled to end this
month.  The Wall Street Journal
prime rate is 3.25 percent, which has not been as low since the mid 1950s.  The historical low levels of interest
rates indicate an increase is inevitable.
 

Predicting the timing and degree of an increase will depend
on both domestic and international economic wellbeing, as well as inflationary
expectations.  Federal Reserve
chairman Ben Bernanke reported that after the most recent central bank policy
meeting, the Federal Reserve does not have immediate plans for a spike in
interest rates.  Market investors
are predicting rates to stay low through the end of the year, with potential
increases beginning in 2012.  

How does this affect farmers?

Increase in interest rates will presumably have the most
effect on farmland prices.  A
recent study conducted at the University of Illinois by Schnitkey and Sherrick
found that a one percent increase could decline farmland value more than 20
percent.

There is still time to borrow money with low interest rates.
The Kansas City Federal Reserve reported the average interest rate on non-real
estate agricultural loans is at 4.86 percent at the end of the first quarter of 2011.

“One piece of advice I will offer is to examine your options
before financing anything,” said agriculture equipment retailer Don Aberle on a Farmersforthefuture.com
forum.  “Sometimes zero percent for
a short term is not the way to go. 
If you can get a higher fixed rate for a longer period, it will free up
more operating cash, but might cost you more in the long run.”

A general rule is to keep interest costs below 20-25 percent
of the farm’s gross income.  Farmers
should assess the impact of a potential increase of interest rates on their
future profit margins and loan repayment ability. 

“Before you go to any lender, do your homework and come up
with at least the basics of a business/cash flow plan to show how you can
afford to pay back the loan and how you will mitigate risk,” Gary Matteson said on a Farmersforthefuture.com
forum.
 

The majority of agricultural loans, 75 percent, are variable
or floating rate loans that will fluctuate as the market changes.  It is important to understand how your
lender will adjust your interest rate as changes in the market occur.  The rest of agricultural loans usually
have discrete points in time, such as monthly, quarterly or annually, when
interest rates can change. 

Read more about