Despite globally tight credit, farm borrowing is still on the upward trend. Compared to last March, Farm Credit Canada’s total volume of loans is up 14 per cent.
At the same time, interest rates are lower, with the prime rate down 275 points, almost 23 per cent lower than last year.
“There’s a lot of discussion around whether to break mortgages to take advantage of lower interest rates,” says Rémi Lemoine, FCC senior vice-president of credit.
So far, it’s mostly talk. Few farmers have taken taken the plunge. FCC rewrites loans every year for a variety of reasons and in the year ending Jan. 31, 2008, it rewrote $950 million. For the year ending Jan. 31, 2009, the rewritten sum increased only marginally to $1 billion.
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The talk, however, may soon turn to action.
Whether you should renegotiate your own mortgages, however, will depend on many factors, says Lemoine.
First, you need the facts. Update yourself on your current loan agreement and payment schedule. Luckily, getting information and advice from your loan manager is free. To make a good decision, you need to know about things like breakage fees, interest rates, loan terms and other options.
Then it is time to crunch some numbers. Obviously, the difference between your interest savings and the breaking fee should give you a guideline as to whether this is a good idea. For instance, dropping your interest rate from six per cent to four per cent on $500,000 will save you $10,000 a year. If your breakage fee is $9,000, you’ll be ahead before the end of the year.
Lemoine suggests you calculate the net present value — how much will amortization length or interest rates affect the amount you will pay out for that loan. “This will give you a total cost of future payments and discount it into today’s cost so you can compare apples to apples,” says Lemoine. If you don’t know how to do that or if you’ve got too much on your plate to take the time, ask your accountant. They love that kind of stuff.
Remember though that a short-term saving may not always be good. If you’re uncomfortable about inflation, sticking with a longer-term loan may be a good alternative for you, helping protect yourself against the risk of interest rate increases.
However, if your savings would be significant and you want to proceed, it’s time to have a more in-depth conversation with your loan manager.
In the last few years this has had a real impact on how farmers are borrowing. More are signing variable or short-term loans, and then they are monitoring interest rates. Last year, 66 per cent of the loans FCC wrote were on a variable rate. Interestingly, the smaller loans are generally longer term.
As of mid-March, the demand for short-term money has caused an interesting shift. Interest rates on variable-rate, open-term loans were higher than one-year term loans. At that time, the one-year rate at a bank was flirting around 3.5 per cent and the best variable rate some bankers were willing to talk about was between four and 4.5 per cent.
If you were on top of it and watched interest rates every week, an open variable rate mortgage would have saved you money in the last 10 to 15 years. Interest rates are not likely going to jump up two or three per cent all of a sudden, says Lemoine. With variable open loans, you can lock in the day they start to climb and overall you save money.
The risk of short-term and variable loans is that inflation will may spike suddenly. That could be a real possibility. If things start to rebound then inflation may kick in and interest rates will increase. Ask anyone who tried to farm paying 20 per cent interest in the 80s: it wasn’t fun.
However, the longer the term, the higher the interest. Five-year term loans were about two per cent over one-year term loans in mid-March.
How you structure your loan is more complex and depends on your risk comfort, cash flow level and what works for your business and life. Your account manager should have some suggestions about splitting your loan between short-term, long-term and variable rate loans. CG
