Time to review farm financing strategy
By Farm Credit Canada
By Farm Credit Canada
July 12, 2017, Regina – Farmers and agribusiness operators should take the opportunity to review their financial strategies following this week’s modest increase in the Bank of Canada’s overnight interest rate, says FCC’s chief agricultural economist J.P. Gervais.
The Bank of Canada increased its overnight target rate by 25 basis points, increasing its lending rate to 0.75 per cent from 0.5 per cent – the first increase since September 2010. (A basis point is 1/100 of a per cent. 50 basis points therefore equals ½ per cent. The basis point is commonly used for calculating changes in mortgage rates and bond yields.)
The overnight target rate is used to set financial institutions’ prime rate, and therefore influences variable mortgage rates. When the overnight rate changes, the prime rate typically changes by the same amount. It also sends a signal to financial markets about economic conditions, which often lead to higher long-term interest rates.
“This increase is not significant enough for most farmers and agribusiness operators to revise their business strategies, but I recommend they consider reviewing their long-term financing options with the expectation that this increase could be the beginning of a slow and gradual increase,” Gervais said.
“It is prudent in the current environment for producers and agribusinesses to ensure they can face a higher interest rate. This will ensure long-term viability if interest rates continue to climb.”
Because mortgage costs are often a key cost in a farming operation, producers need to decide whether to go with a fixed rate or a variable-rate mortgage, based on sound information and an assessment of personal risk tolerance. While variable rates may offer a lower cost of borrowing, they could prove more costly in an environment of increasing interest rates.
“If a producer is already carrying significant financial risk, then reducing the risk of rising interest rates risk may be a smart strategy,” Gervais said. “Although everyone wants to save money, sometimes it’s prudent to proactively take risk off the table. I’m not saying that everyone should lock in; however, every producer needs to understand what different scenarios might mean to them and do what’s right for their business.”
OTHER FINANCING CONSIDERATIONS
Fixed rate advantages
• Protection against rising rates until the end of the fixed-rate interest term (the longer the term, the more constant the costs).
• Easier to predict interest and principal costs to calculate profit/losses.
Fixed rate disadvantages
• Generally, fixed mortgage interest rates are higher than variable. Therefore, the longer the term, the higher the interest rate.
• Break fees or prepayment penalties may be incurred if the loan is paid off prior to the end of the term.
Variable rate advantages
• Studies show that historically, variable rate mortgage owners pay less most of the time if interest rates are falling.
• Ability to convert to fix without penalty.
Variable rate disadvantage
• Risk of higher rates if prime increases.
Learn more about interest rates by visiting FCC. Producers who want to review or establish their financing strategy can contact the nearest FCC office at 800-387-3232.