Posted  26 Sep, 2017 
In: Articles

Originally published September 18, 2017 on Agri-News

Determining if and how soon to act when rates do start to rise will be based on several factors. In view of rising interest rates, an issue that may come up during mortgage loan term negotiations is whether to lock into a fixed long-term mortgage rate or stay in a variable rate.
“Knowing your interest costs and your farm’s sensitivity to an interest rate increase is a good start,” says Rick Dehod, farm financial specialist, Alberta Agriculture and Forestry. “Should farm margins change, and weather events happen, it’s important to figure out in advance whether the farm’s loan repayment capacity can handle a 2, 4, or 6 per cent increase in interest rates.”
Debt servicing analysis is broken down into two main sections – debt servicing capacity (DSC), and debt servicing requirements (DSR). These are calculated as follows:

  • DSC is accrued net farm income + depreciation expense + interest expense + off-farm income – family withdrawals – farm income tax paid
  • DSR is the total accrued interest expense + total term loan principal payments (for a fiscal year)

“The difference between DSC and DSR must be positive,” says Dehod. “Once you’ve done the calculations using current numbers, see if the farm can withstand an interest rate increase of two per cent. Add two per cent to your average interest rate on all of the farm’s debt to calculate the total accrued interest expense. Then check to see if the difference between your DSC and DSR is still positive, or if the increase in interest rate significantly changes your repayment risk.”

Lenders often use a debt servicing ratio (DSR) calculated as DSR = DSC / DSR. Industry benchmarks for this ratio vary from one financial institution to another, but generally, the following benchmarks apply:

  • greater than 1.5 is low risk
  • to 1.5 is medium risk
  • less than 1.1 represents high risk

“Remember, interest rates are part of your interest expense calculation, and your interest rate doesn’t show up on your income and expense statement,” says Dehod. “The other part of the calculation of interest expense is what you owe. If, in the short run, you have an aggressive principal repayment plan to reduce your farm’s total debt, then an increase in interest rate may not worry you. But if you don’t, fixing your interest rate may be a good option.”

Currently, mortgage funds are readily available to agriculture producers as banks compete for market share and to retain good customers. “It’s a good time, for those who have not got the financial flexibility to endure a large interest rate hike (typically beginning farmers and those who have chosen to significantly grow), to look at a fixed rate and negotiate the best possible five-year fixed rate. Any potential extra cost for peace of mind now appears a short term price for long term viability. Fixing your interest rate could be the insurance you require to manage your financial risk. As each producer and farm business manager has a different risk appetite and risk mitigating strategy, the choice remains an individual one.”

For more information, see the Farm Manager – Your Business resource, A Farmer’s Guide to Agricultural Credit, or call the Alberta Ag-Info Centre at 310-FARM (3276).

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