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May 7, 2004 Producers Should Plan for Higher Interest Expense in 2005 Interest is a major cost for agricultural producers, so it’s not too early to plan for higher interest expenses in 2005, according to Andrew Swenson, farm and family resource management specialist with the North Dakota State University Extension Service. “Most farmers are currently focused on other costs such as fuel and fertilizer, which have increased for the 2004 crop year. However, interest expense per farm has exceeded the cost of fuel in each of the past ten years.” According to North Dakota Farm Business Management Education Program information, farmers spent 34 percent more on interest than on fuel and oil in 2003. “In fact, from 1998 through 2000, interest expense was the second largest cost item, greater than fertilizer, chemicals, repairs or seed,” Swenson says. “Land is always the greatest single cost item.” Total interest costs are a function of interest rates and the amount of debt. Over the past decade, average debt has increased with farm size. However, interest expense per farm has actually declined each of the past three years because of lower interest rates. “This trend will probably continue for 2004 because interest rates for operating and term loans have largely been fixed for the year,” Swenson says. However, Swenson is confident that interest costs per farm will increase in 2005. The general level of interest rates has increased recently and there is a growing consensus that rates will continue higher. On May 6, the rate on the benchmark 10 year U.S. Treasury note hit an eight month high. Interest rates on home mortgages have increased for eight consecutive weeks. The Federal Reserve indicated at their May 5 meeting that future "measured" interest rate hikes are likely. “No one knows
for certain what interest rates will be in the future,” Swenson
says. “The interest rate is simply the price of money. Producers
are aware of how difficult it is to predict the future price of other
inputs such as fuel and fertilizer or the price of outputs such as corn
and soybeans. Because interest costs are major cost item, producers should be thinking of ways to lessen the impact of a rise in interest rates. “One sure strategy is to pay down debt,” Swenson says. “Obviously a change in rates has no impact on interest costs of the producer with zero debt.” In recent years, in an environment of declining interest rates, borrowers have reaped substantial savings by choosing an annually adjustable interest rate versus fixing the rate over a multi-year period. The opposite strategy is generally more favorable when there is a sustained period of increasing rates. However, locking in or fixing rates comes at a cost. The immediate result of converting from an adjustable rate to a fixed rate is to pay more interest. “For the strategy to work, future adjustable rates must become higher than the current fixed rate,” Swenson says. “Generally, the shorter the length of the loan and the slower the ascension of interest rates, the more likely the producer is better off staying with adjustable rates.” Swenson recommends that producers look at the intermediate and long-term debt on their balance sheet. Often these loans have a one year or three year adjustable interest rate even though the term of the loan is 5, 10 or 20 years. “Calculate the increase in costs at higher interest rates and consider the impact on future cash flows,” Swenson says. “Get current quotes from lenders for adjustable and fixed rates. Lastly, ask yourself whether the immediate increase in interest costs from fixing rates over a longer period is warranted to reduce interest rate risk and potentially save interest costs in the future.” ### Source: Andrew
Swenson, (701) 231-7379, aswenson@ndsuext.nodak.edu |
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North Dakota State University |
