Steadily Changing Interest Rates Affect Farmers

Rates for real estate and farm operating loans can affect farm and ranch borrowing. Compiled by staff

Published on: Jun 14, 2005

Real estate and operating loans are a business basic for most agricultural producers. So it's no surprise that farmers and ranchers join financial experts in wondering whether the Federal Reserve Board will continue its "measured" approach to increasing interest rates.

Minutes from the Fed's meeting in May suggest there's a bias toward continuing to raise the key Federal funds rate above its current 3.0% level in an effort to stem inflation. But there's also evidence that inflation remains in check.

"The Fed usually implements shifts in monetary policy over about a 12-month period. The current round of increases has taken 10-months," notes Dave Hoyt, vice president of finance with Farm Credit Services of America or FCSAmerica. "If inflation remains tame, I believe the current round of increases will cease with the next compelling signal of stress in economic growth."

Headquartered in Omaha, FCSAmerica serves the credit and insurance needs of more than 62,000 farming and ranching customers in Iowa, Nebraska, South Dakota and Wyoming through a network of 43 retail offices.

The Federal Funds rate has an indirect impact on the interest rates farmers and ranchers pay for real estate and operating loans, says Hoyt.

"Since the early 1990s, most lenders have consistently maintained their prime lending rate at 3% above the target Federal funds rate, and in all likelihood that will continue," he says.

Differing impact, depending on type of loan

The impact of rising rates differs depending on the type of loan a customer has, Hoyt says.

"It's very common for farm or ranch operating loans to have a variable interest rate, and variable rates have a very high correlation to movement in the prime rate," he explains. "When the prime rises or falls, so does the variable rate on the operating loan."

Fixed interest rates are more common for equipment loans and mortgages. Short-term fixed rate loans - those with a term of five years or less - tend to have a higher correlation to prime rate movements than longer-term fixed rates.

"Of course, there's no effect on an existing loan with a fixed rate," Hoyt notes. "And the interest rate market for new, fixed-rate loans is affected by general economic growth, inflation expectations and government spending, so these rates don't necessarily move with prime rate adjustments."

Interest rates are just one factor

Hoyt says interest rates are just one factor in a sound borrowing program.

"The customer's repayment capacity - the ability to repay a loan with interest - is a key consideration for lenders," adds Hoyt. "Rising interest rates may affect the lender's credit analysis, but it won't generally make or break a deal to an otherwise credit-worthy customer in the typical range of interest rates. When rate movements become extreme, though, this can be more of a factor."

Managing your monetary risk

Hoyt says customers' differing circumstances means there's no single approach to managing the risk of rising interest rates.

"Variable rate debt often is less costly than fixed rate loans, but the customer must be able to bear the risk that rates will move higher," he explains. "Farmers and ranchers with strong repayment capacity, or who have strong capital positions, can often handle the interest rate risk that's inherent in variable rate loans. But those without much excess repayment capacity should probably use more fixed rate debt."

For farmers and ranchers who are keeping a close watch on interest rates and the economy, Hoyt has this last piece of advice.

"Every producer's situation is different. The best approach is to work with an experienced lender to determine how much risk you can stand, and then choose a financing program that best fits your operation's needs."

Farm Credit Services of America is proud to finance the growth of rural America, including the special needs of young and beginning producers. With over 62,000 customers, assets of $8.5 billion and a patronage program, FCSAmerica is one of the largest providers of credit and insurance services to farmers, ranchers, agribusiness and rural residents in Iowa, Nebraska, South Dakota and Wyoming.