Many farmers use debt to finance seasonal expenses. However, a loan can also help farmers refinance and remain more resilient through hard times by providing funds for expansion and greater sustainability as a business.

“Fundamentally, debt is a tool; it’s neither good nor bad in and of itself, like any other tool,” said Andy Larson, farm outreach specialist at the Food Finance Institute at the University of Wisconsin in Madison, during a recent webinar put on by Food Animal Concerns Trust, “Farm Loans: How and When to Use Debt to Finance Your Farm Business.”

Regarding debt, Larson said that many people have “heard horror stories in their lives about repossessions, bankruptcies or farm auctions.”

That’s not always the case. Mortgages sometimes get paid off early. Lenders may also have your best interest at heart.

Rather than thinking of debt as an undesirable option, Larson said the key is to think about it as rent on an asset that the business needs for peak productivity. “A lot of you probably rent vehicles, facilities or farmland, but a little extra money can help you farm better,” he said.

Loan basics

Larson defines financing as providing funding for an enterprise. Equity is ownership of an asset. Collateral items are assets securing debt.

“Those are things the bank takes back to sell if you don’t make good on your loans,” he said.

A lien is a legal claim on assets. A mortgage or ag security agreement are examples. Chattels are non-real estate assets, such as tractors, livestock, processing equipment or many other items.

Default means to break a loan agreement. A guaranty is a third-party promise to help make a lender whole in a collections situation. 

Whether a farmer should get a loan depends on a lot of factors. But someone just starting in the business should not get an agricultural loan, Larson said, adding that gaining farming experience “on someone else’s dime” is much better than taking out loans to start farming.

Management and marketing separate the successful farmers from those who are not. He calls record keeping the backbone of making smart farming decisions.

Using one’s personal money is also required, in addition to sweat equity.

“It demonstrates commitment to the enterprise,” Larson said.

The farm’s business plan should show a potentially profitable business model that will only grow with a loan.

Loan options

The three main types of farm loans include short-term loans or lines of credit that include operating capital for the current growing season.

“With a loan, you get the proceeds upfront, and you pay interest on the entire amount that you borrow; lines of credit get you into a line of availability as you need them. You only accrue interest on what you’ve advanced, not the entire line of credit,” Larson said, adding that they are expected to be paid off once the producer sells the goods raised in that season or year. Chattels are oftentimes used as collateral.

Intermediate-term loans take two to 10 years to pay off and are used to buy machinery, trucks, titled vehicles and breeding livestock.

“The amortization period of the loans often depends on the useful life of the asset purchased with the loan proceeds,” Larson said.

Long-term loans take 10 to 30 years to pay off. This includes real estate and improvements, secured by mortgage.

Choosing a lender does not have to be complicated, but not all banks will loan to farmers or agricultural businesses. The good news is that many farmers already have an existing relationship with a lender or at least know them by their local reputation.

Lenders may partner with outside organizations, such as the Farm Service Agency or the Small Business Administration, depending on the project that’s being financed. Farmers can also use more than one financial institution. Larson encourages finding a lender that specializes not only in farming, but also in the type of agriculture the farmer is involved in.

What you’ll need

Lenders will likely need to see two to three years’ worth of tax returns, business income, other income, revenue and expense trends, tax burden, capital gains or losses, depreciation schedules, what’s available for collateral, working capital position, accrual adjustments, and net worth.

For a new enterprise, Larson said a lender will also need to see a business plan so they can tell how the money will be repaid.

Credit decisions can take time, he said, but having complete information available can help expedite the process.

Non-bank lenders should also be considered, as should financial organizations that serve small businesses or farms, and dealer or seller financing. Leasing may also help some farmers.

Other types of financing include leasing, forgivable loans, grants and cost shares.

Beginning farmers face greater risk because of their inexperience, Larson said. That is why banks are less likely to loan money to new farmers. He said new farmers should minimize the amount they need to borrow and instead focus on demonstrating the soundness of their business model. This could include leasing land, borrowing equipment, keeping good records and filing a Schedule F.

The business plan should also highlight a farmer’s ability to establish their market, demonstrate cash flow, reinvest in the business, save for down payment, build momentum and bootstrap the business.

To “sell yourself” to a banker, a new farmer needs to “keep your day job,” Larson said. “A majority of farmers in the U.S. rely on off-farm jobs for benefits and regular income.”

Farmers should also treat the business like a business with a separate checking and debit account. The balance sheet should be completed every Dec. 31, or more often.

“Know cost of production and don’t guess,” Larson said. “Know what’s going into the cost of whatever agricultural commodity you’re producing.”

He also suggests going to meet bankers before the first agricultural loan need arises, along with a tax adviser, financial planner and more.

“Be responsible with the debt you get into,” Larson said. “Have a plan built on data, not wild guesses.”  

Sergeant writes from central New York.