Are You Successfully Managing Farm Debt?
Unless you’re debt-free, you have probably spent some time thinking about how to manage farm debt and the interest on it.
Where can you get the best rates? Should you choose long-term or short-term financing? Fixed rates or floating rates? What should you put up as collateral? Which loans should be paid off first? How much debt is too much?
Explore All Options
Your financing options include Farm Credit Services, local banks, national banks, and international banks. The USDA also makes operating and ownership loans, and extensive information on that is available on its website.
So, who should you talk to about loans? In my opinion, all of them.
I can’t tell you how many times a client has approached me with this statement: “I talked to my bank, and they said, 'No,’ so I gave up.” I send them out of my office with three more loan officers’ names and numbers, and they almost always get a loan.
Introducing a little competition will often yield better rates on your loan and improve the likelihood of getting one.
What most people don’t realize is that every bank is in a different financial position, and that position changes on a monthly basis. Sometimes a bank just wrote off a large commercial loan and is not in the mind-set to make another one.
Furthermore, the federal bank examiners who monitor your bank may not allow it to make additional loans at this time due to capital limitations. It’s not personal; the bank always has to consider its own financial situation in addition to yours.
Where are rates today? On the high end, small loans on titled equipment are running as high as 6% or 7%. Untitled equipment loans over $75,000 are at about 4.5% now and so are 10-year term loans on cropland. Twenty-year fixed rate land loans can be found for about 5%.
On the low end, I have seen floating rate credit lines as low as 2.75%. A lot of people stay away from floating rates for fear of rapid punitive rate increases. However, over the last 25 years I’ve never seen rates rise at an unmanageable pace.
The key to whether or not you can take on the risk of floating rates lies in whether or not you have a way to pay off the loan in the worst-case scenario, i.e., do you have an emergency funding source?
Line of Credit
What could be your emergency funding source? A home equity credit line, a margin loan on stocks and bonds, or your in-laws. The last two get a little dicey, but the first one can be pretty slick.
Though my house is paid off, I keep a floating rate credit line available on it at all times. My equity loan cost $0 to establish, and it also costs $0 to maintain. The current rate is variable and somewhere around 3%. I can write a check on the line any day and also pay it off at any time. It’s free liquidity, so why not have it available? (One caveat: Under the new tax bill, home equity line interest on debt that is used for non-home-acquisition purposes is not deductible.)
Note that I did not mention credit cards as an emergency funding source. With the late fees and potential variable rates that can approach 20%, just say no. All credit card balances should be paid in full every month as soon as the bill comes.
Why pay it quickly? To head off the possibility of the credit card company slow-walking your payment and calling it late. Besides causing annoying late fees, this also damages your credit rating. And your good credit rating is a huge factor if you are trying to minimize your interest costs. Never be late with any payment of any kind. Try to keep that FICO score above 700 to maintain the best rates.
Getting Lowest % Rate
As you know, you can use various things around the farm as collateral: your home, farm vehicles, large equipment, your land, or the operation as a whole. What should you put up? My answer: Whatever will get you the lowest interest rates.
If large equipment loans have better rates than small equipment loans, don’t have debt on small equipment.
If your home parcel will get you a lower rate than outlying fields, then use it. Maximize the lowest interest debt and minimize the highest.
When you are on a plan of paying off loans, clearly you want to pay them off in the order of highest interest down to lowest. This is a simple rule, easy to understand, yet I see people violating it all the time. They pay off a car loan and leave a $10,000 credit card balance outstanding.
Should You Lease?
Leasing is another financing option. It’s best to think of an equipment lease as just a loan by another name. They are using an interest rate to calculate your lease payment. You just need to figure out the imputed rate and make sure it’s not outside of the normal range.
Years ago leasing companies could make 10% to 20% on a lease because lessees were not doing the math, but those days are over. Imputed lease interest rates should be on par with loan rates. Otherwise, just go get a bank loan at 4.5%.
Length of Financing
The question of long-term vs. short-term financing is always a quandary. Lock in 5% for 20 years, or roll the dice at 3% on a variable-rate loan? Only people who can see into the future can accurately answer this one, but rolling the dice would have been the way to go during the last 20 years.
Currently, everyone predicts rates to increase, but it may take 20 years for short-term rates to move from 3% to 5%? With U.S. government debt at $21 trillion, where do you think they want interest rates?
Too Much Debt?
The last thing I want to talk about is a huge issue – how much debt is too much? Some big farm investors are totally comfortable at 75% loan to value. Others try to stick to 50%.
You have to decide for yourself what your debt limit is. Do not rely on your banker to keep you out of trouble. Do not assume that you should borrow more money just because a bank is willing to lend it. The bank has hundreds of other borrowers to think about and may spend little time worrying about whether or not you will go bankrupt.
How do you figure out what the limit is? Think about the worst-case scenario on your farm in a given year – flooding, drought, and equipment failure.
If all of the bad things happen, can you still make the old loan payments and the new loan payment? If you can, then go ahead and take out the new loan.
Banks hate to finance more than 80% of purchase prices, but there is nothing magic about that number. You may need to keep your debt to 42.6% of your assets in order to be sure that you can make all of the payments.
You never want to put yourself into a liquidity crisis and have to sell critical assets to get a little cash. No one wants to see a replay of the 1980s farm crisis.