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When purchasing farmland, it’s important to consider not just the cost of the property itself but also the interest rate. It’s not easy to time the market, but you should aim to purchase or refinance when mortgage rates are low.
Locking in a low mortgage interest rate will result in a lower monthly mortgage payment and less interest paid to the mortgage lender. While a 1% difference may sound relatively insignificant now, it can really add up in the long run.
There is no single governing body or institution that determines farmland mortgage interest rates. Rather, mortgage rates are impacted by a number of factors related to both the economic market and the individual buyer.
Economic factors that can impact farmland mortgage interest rates include:
Federal funds rate
Bond market
Number and strength of lending institutions serving the market
State and federal regulations on lending
Loan type including fixed vs. variable, term and amortization, and prepayment penalties
Supply and demand for credit
Global economic trends and conditions
Factors unique to the borrower that can impact mortgage interest rates include:
Employment history
Credit score
Debt-to-income ratio (DTI)
Key balance sheet metrics
Key income metrics
Loan amount
Loan-to-value ratio
Down payment amount on the property
Collateral
Loan type
Geographic location
In general, staying up-to-date on the economy and on your personal financial position can help you forecast possible mortgage rate fluctuations. It is best to speak with a loan advisor to understand current market conditions and the unique financial opportunities that are available.
The Federal Open Market Committee (FOMC, also known as the Fed) does not directly set mortgage interest rates, but its actions can significantly influence them. It sets the interest rate at which depository institutions, such as banks and credit unions, lend reserve balances to other depository institutions.
With dual mandate objectives to promote price stability and maximum sustainable employment, the Fed targets a moderate level of inflation of around 2% annually. When the economy is slowing down or in a recession, it may lower the Fed Funds Rate to stimulate economic activity.
When the Fed lowers the federal funds rate, it generally leads to lower interest rates across various types of loans, including mortgages. This happens because lower federal funds rates reduce the cost of borrowing for banks, which can then pass on these lower costs to consumers in the form of lower interest rates on loans and mortgages.
Because the average cost of U.S. farmland can range from $3,000 to $14,000 per acre, many farmers use land loans to finance farmland purchases. When purchasing farmland, it’s important to consider not just the cost of the parcel of land itself but also the interest rate of any financing you might be using to fund your purchase.
Ideally, you should aim to purchase or refinance when mortgage rates are low. Locking in a low mortgage interest rate will result in a lower monthly mortgage payment and less interest to your mortgage lender.
While a 1% difference may sound insignificant, it can add up in the long run. A 1% increase in a mortgage rate of 6% to 7% for every $100,000 results in an additional $801/annually. Over the lifetime of a 30-year loan this adds up.
For example, a borrower with a 30-year fixed loan for $750,000 at 7% interest has an annual payment (principal and interest) of approximately $60,440.
However, at just 1% lower at 6% interest, the annual payment drops to about $54,487. This is an annual savings of $5,943. This adds up to $178,693 in total interest savings over the course of 30 years.
It’s important to compare rates and stay on the lookout for opportunities to refinance if possible. The money saved from a lower interest rate can be redirected toward:
Investments: Compounding returns from investing the monthly savings can grow wealth over time.
Farm improvements: Expanding operations, upgrading equipment, or improving infrastructure can boost farm profitability.
Debt reduction: Applying the savings toward principal payments on other loans reduces overall debt faster.
By understanding how loan terms and amortization impact overall loan costs, you can make more informed decisions that align with your financial situation and long-term goals.
The loan term is the length of time over which the loan is scheduled to be repaid. Common loan terms include 10, 15, 20, and 30 years.
Shorter Loan Terms | Longer Loan Terms |
Lower interest rates: Lenders typically offer lower interest rates for shorter loan terms because the risk of default is lower over a shorter period. Higher monthly payments: Although the interest rate is lower, the monthly payments are higher because the loan principal is repaid over a shorter period. Less interest paid overall: You pay less interest over the life of the loan because the loan is repaid more quickly. | Higher interest rates: Lenders often charge higher interest rates for longer loan terms due to the increased risk of default over a longer period. Lower monthly payments: Monthly payments are lower because the loan principal is spread out over a longer period. More interest paid overall: You pay more interest over the life of the loan because it takes longer to repay the principal. |
Amortization refers to the process of paying off a loan through regular payments over time. Each payment covers both interest and a portion of the principal.
Fully Amortizing Loans | Partially Amortizing Loans |
Consistent payments: Monthly payments remain consistent throughout the loan term, covering both interest and principal. Interest vs. principal: In the early years, a larger portion of each payment goes toward interest. Over time, more of each payment goes toward reducing the principal. Interest costs: The total interest paid over the life of the loan depends on the interest rate and the loan term. | Balloon payments: Some loans may have a balloon payment at the end of the term, where a large portion of the principal is due in a single payment. Interest costs: These loans may have lower monthly payments initially but can result in higher interest costs if the balloon payment is not managed effectively. |
There are two interest rate loan types: fixed and variable.
Fixed interest rate loans are loans in which the interest rate will remain constant for the entirety of the loan term, regardless of market interest rate activity. Since the interest rate does not change, borrowers can predict their monthly payments and budget accordingly. This stability can be particularly beneficial for long-term financial planning.
Borrowers are protected from potential increases in market interest rates. If interest rates rise, the fixed-rate loan remains unaffected, which can result in significant savings over time.
Fixed-rate loans might have higher initial interest rates compared to variable rate loans. However, the trade-off is the stability and predictability they offer.
A variable rate loan, also known as an adjustable rate loan, has an interest rate that can change over time. This means that your monthly payments can vary over the life of the loan.
The rate is typically tied to a benchmark or index. For real estate loans, this is typically based on a lender’s cost of funds, which may closely correlate with the pricing of Treasuries or other bonds. Consequently, it can increase or decrease based on changes in the underlying index or benchmark.
Many variable rate loans start with a fixed interest rate for an initial period, which can range from a few months to several years. The frequency of rate adjustments can vary. Common adjustment periods include monthly, quarterly, annually, or every few years, depending on the loan agreement.
Variable rate loans can have caps (limits on how much the interest rate can increase) and floors (limits on how much the interest rate can decrease). These caps and floors provide some protection against extreme rate changes.
When choosing between a fixed or variable rate loan, there are five key things to consider based on what you may be looking for in your loan.
1. Anticipated Length of Loan
If you anticipate refinancing your loan in the near term, a variable rate may better suit your needs. This could be due to an expected farm transition or if you anticipate financing additional land/resources in the near future. However, if you foresee holding the loan for an extended term, the predictable payment structure of fixed loans may be preferable.
2. Risk Tolerance
Understand your personal tolerance for risk. While one benefit of a variable rate loan is that the interest rate may decrease, the inverse may also occur and rates could go up. Knowing how comfortable you are with that dynamic is very important when making your decision.
3. Desired Payment Amount
If you have a targeted interest payment amount, analyzing which loan type will provide an interest payment closest to that amount will aid your decision.
4. Current Spread Between Fixed and Variable Rates
Take stock of where rates are sitting when you are ready to close a loan. The magnitude of the spread — i.e. how far apart the variable rate is from the fixed rate — is an important piece of information to be aware of when making your decision.
5. Ability to Modify Rate
When interest rates decrease, some lenders, including FBN on most products, allow you to modify the rate on your loan for a fee. While the other terms of the loan, such as amortization, will not change, lowering your interest rate will lower your overall payment.
Lenders will review your financial statements, including balance sheets, income statements, and cash flow statements, as well as your tax returns, which will show whether you have sufficient income to cover future repayment, living expenses, and financial obligations. Strong financial statements with healthy profit margins and low levels of debt can lead to better interest rates.
If you have a low credit score, you will be considered a riskier borrower. Late payments and having a high debt-to-credit ratio can hurt your credit score. Consider paying down your account balances to improve your credit score.
Demonstrating steady and sufficient income (strong debt-to-income ratio) not only increases your chances of approval but also positions you for more favorable financing terms, helping you secure the land you need for farming or investing.
However, if your farm has struggled to break even or become profitable, lenders may be concerned you will not have the funds to pay your loan. That said, a well-prepared business plan that outlines your operation's goals, strategies, and financial operation’s projections can positively influence lenders' perceptions of your operation's viability and potentially reduce your interest rate.
The value and quality of the collateral you offer can also impact your interest rate. High-quality collateral reduces the lender's risk, potentially resulting in a lower interest rate.
At FBN Finance, we offer competitive rates and tailored land loan financing solutions that meet the unique needs of farmers like you. With a transparent process and clear communication about all associated costs so you know exactly what to expect, we’re here to guide you through every step of the financing process. With FBN Finance, you get the benefit of competitive rates, specialized agricultural expertise, and an experienced partner who truly understands your business.
Complete the brief form below or call 866-619-3080 to speak directly to a member of our FBN Finance team today.
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Written by Norm℠, reviewed and edited by Mikaela Tierney.
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