Rethink long-term borrowing strategies

Variable-rate loans, or loans with a fixed rate for a relatively short period that then turns into a variable rate, have served many people well over the past decade. A period of low interest rates kept rates reasonable, even with variable rates in play. A pair of Purdue University ag economists suggest that ploy may no longer be a smart move in the future. The future could arrive in 12 to 24 months.

The entire chain of logic leading to their conclusion is complicated. Suffice it to say it revolves around repercussions of the bailout of banks and current attitudes toward lending by bankers. Basically, many bankers have turned conservative and aren’t making nearly as many loans as in the past, notes Allan Gray, Purdue Extension ag economist.

“If nothing is done, we could see double-digit inflation within the next few years,” says Gray. “I don’t think it will happen, because the Fed will take action to slow down inflation before that occurs.”

Key Points

• Variable-rate loans work well as long as interest rates remain low.

• Inflation and interest rates could increase significantly if the Fed doesn’t act.

• One strategy is seeking out lenders willing to make longer-term fixed loans.

Cause and effect

The problem, adds Mike Boehlje, also a Purdue ag economist, is that if the Federal Reserve System raises interest rates too fast to head off inflation, it could put the tentative recovery into a tailspin. That’s not likely to happen either, both agree.

However, both believe interest rates will likely rise. How much they’ll increase is anybody’s guess. Increases in interest rates could begin after the next 12 months, Boehlje says.

While neither ag economist will make hard and fast projections, they’re confident that the situation will swing back in the direction of higher interest rates. They believe this possibility should affect a shrewd manager’s thinking as he or she looks ahead.

“We’re saying this ought to be part of your management strategy going forward,” Boehlje says. “How are you going to handle your financial debt if interest rates for loans increase? That’s the real question you should wrestle with today.”

Different options

One option would be looking at how much debt is tied up either on variable-rate loans, or loans that are fixed now, but which will become variable-rate loans in the near future. That’s how some loans are written.

A wise strategy for certain individuals could be trying to convert more of that debt to long-term loans at reasonable fixed rates now, Boehlje says.

Finding an institution willing to make long-term loans could become an issue. Many banks aren’t lending long-term money, Boehlje notes.

Your best bet, he says, could be checking with traditional ag lenders. See if some of them might be willing to make a loan with a fixed interest rate and a term of at least 10 years.

This article published in the March, 2010 edition of INDIANA PRAIRIE FARMER.

All rights reserved. Copyright Farm Progress Cos. 2010.