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Serving: IA
Planter in field Rod Swoboda
EXTRA FEES: When refinancing or restructuring a loan, non-trivial fees must be taken into account when calculating the net returns to the operation.

Time to refinance ag loans?

Timely Tips: Should you get a fixed rate loan for as many years as possible?

Each month in Wallaces Farmer magazine, the Timely Tips panel answers questions sent by readers. Members of the Timely Tips panel are Alejandro Plastina and Wendong Zhang, Extension economists, Iowa State University; Leslie Miller, Marion County Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa. Following are the questions they are answering this month.

In response to the COVID threat, I think the Federal Reserve will keep pushing interest rates lower, if not lower, at least at stable low rates. Will long-term interest rates fall further? How do I figure out when to refinance my real estate debt? The economy seems likely to slip into recession. I fear the federal government deficit spending at an unprecedented rate will eventually trigger a burst of inflation. Should I get a fixed rate loan for as many years as possible?

Stout: The Federal Reserve lowered short-term rates to 0% to 0.25%, which is likely where they will stay for a while. Japan and some European countries have lowered their rate below zero, but the Federal Reserve has never done that and indicates it is not considering it. The Fed has also been purchasing bonds to put some money into the economy.

If you look up U.S. Treasury bond rates, they rise from one month all the way to 20-year bonds as each increment of time is added. That means, at this time you can lock in your rates for five or 10 years at lower rates than 20 years, in most cases. I don’t expect interest rates to rise until the economy shows signs of a good recovery. I also don’t expect them to fall substantially.

You should be able to find 20-year rates under 5%, five-year rates under 4%, and variable rates even lower. If you are refinancing notes that have 20 years left on them, I would go with the 20-year loan. But if you only have 10 years left on your debt, I would stick with the 10-year debt at a lower interest rate, which makes your total debt service costs less. At some point in the future, the extra government spending due to the pandemic will need to be repaid and, potentially, could lead to inflation and higher interest rates.

Plastina: Interest rates have little room to go lower in the near term, but economic activity in the ag sector as well as in most other sectors of the U.S. economy will stagnate at best and likely contract for a prolonged period of time. In such a scenario, inflationary pressure is highly unlikely, despite the ever-increasing national fiscal deficit.

Refinancing real estate debt with fixed low interest rates might be a reasonable option under mainly three scenarios:

  1. to free up liquidity by extending the repayment period and reducing total annual payments
  2. to free up liquidity by moving debt under a lower interest rate loan while maintaining the repayment period unchanged
  3. to educe uncertainty if your current interest rate is variable

Scenarios one and two resonate well with farmers facing a persistent erosion of liquidity in recent years.  Scenario three resonates well with farmers who face a balloon payment and variable interest rates. It’s important to note that restructuring a loan or refinancing typically involves non-trivial fees that must be taken into account when calculating the net returns to the operation.

A fourth scenario that might be relevant for a small group of farmers with consistently high profitability involves shortening the repayment period to cancel the obligation earlier than originally planned. In this case, consulting with a tax adviser is highly recommend.

Miller: Now is a very good time to refinance debt and fix rates — with the goal of restoring some working capital to your current position and making your payments as low as possible. If you have very low payment levels, it will improve your ability to survive the current low prices. Having sufficient working capital will cushion the blows that could come from future loss years.

When refinancing, it’s important to work with a lender that doesn’t use prepayment penalties. That way, if prices improve faster than we think, you can pay ahead on that debt and shrink the amount of interest you pay over time. 

In the current environment, long-term rates have had difficulty moving below their current levels because investors believe inflation will come back into the picture. Historically, rates have usually gone up and come back down within a five-year time period. So, even when financing real estate, if you can get a really low five- or seven-year fixed rate, that might be the term to use, provided the loan has a 20-year amortization.

 

TAGS: refinancing
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