MAXIMIZING THE VALUE OF YOUR FARM DEBT REPAYMENTS

Originally published on July 2, 2009

 

Farming is one of the most capital intensive professions on the planet.  Farming with debt or as the old-timers put it “running a blistered farm” is standard practice.   This past month after securing financing for a client, the banker enthusiastically told me that “it'll be the cheapest money the farmer ever borrowed".   With interest rates at record lows, this is the reality and for this reason you should review your farm loans and mortgages to ensure that you are maximizing the value of your farm debt repayments.

What rate are you paying?

The first step in evaluating your farm debt repayments is to determine your cost of borrowing.  On each of your farm loans or mortgages, you are required to pay either a fixed or floating interest rate, which is the borrowing rate you had previously agreed to.

An increasing number of Prairie farm managers are keeping their farm loan and mortgage information together in one file or binder.  This file or binder would hold the initial documents, lending covenants and your respective loan or mortgage repayment schedules.  By keeping this information in one place, you will be able to track the effect of your principal and interest repayments,  identify any covenant violations,  upcoming mortgage renewal dates and which high cost debt should be paid off first.

The benefits of consolidation

Replacing higher cost debt with one lower-rate loan or mortgage will typically save you more than you think.  To illustrate this, let's assume you had three five-year $100,000 loans on which you had borrowed at rates of 7.5%, 8.25% and 6.25%.  You have the opportunity to consolidate this farm debt into one loan at a much lower rate of 5.25%.  While you know it's worth doing,  what is the actual benefit?

In table one I've computed the savings generated by consolidating these loans to the lower 5.25% borrowing rate.  In the far right column titled "Difference", we see that over five years, the consolidation loan puts an additional $18,806 in your pocket.

Table One            
  7.50% 8.25% 6.25% Total 5.25% Difference
Interest            
2009 7,184.03 7,908.45 5,978.91 21,071.38 15,051.09 6,020.29
2010 5,872.28 6,485.31 4,860.38 17,217.98 12,181.60 5,036.38
2011 4,460.32 4,942.35 3,670.85 13,073.52 9,159.48 3,914.03
2012 2,940.47 3,269.46 2,405.82 8,615.75 5,976.62 2,639.12
2013 1,304.50 1,455.71 1,060.49 3,820.69 2,624.47 1,196.22
  21,761.59 24,061.28 17,976.44 63,799.32 44,993.27 18,806.04

The benefits of carrying your farm debt in a corporation

Farm debt within a corporation will be paid back much faster than if it were held personally. For this reason, if you have a corporation then you should be borrowing there first.

To illustrate this, let's assume that we have $40,825 of annual income which our non-incorporated and incorporated farmers will be applying net of tax to their farming debt.  For the non-incorporated farmer in the middle bracket,  he will pay approximately $14,289 of income taxes on this income leaving him with $26,536 to be applied to his farm principal and interest payments.  At the top of table two, we see that after 14 payments the debt is extinguished.

 

 

For the incorporated farmer applying the same $40,825 of annual income, net of tax to his farming debt, he is able to get the loan paid much faster.  At the bottom of table two, we see that after 10 payments the debt is extinguished. 

Table Two            
Debt Held Personally            
  Beginning Balance Interest Principal Loan Payment Tax Payment Total Cash Payout Ending
1 300,000 7,875 18,661 26,536 14,289 40,825 281,339
2 281,339 7,385 19,151 26,536 14,289 40,825 262,188
3 262,188 6,882 19,654 26,536 14,289 40,825 242,534
4 242,534 6,367 20,170 26,536 14,289 40,825 222,364
5 222,364 5,837 20,699 26,536 14,289 40,825 201,665
6 201,665 5,294 21,243 26,536 14,289 40,825 180,422
7 180,422 4,736 21,800 26,536 14,289 40,825 158,622
8 158,622 4,164 22,372 26,536 14,289 40,825 136,250
9 136,250 3,577 22,960 26,536 14,289 40,825 113,290
10 113,290 2,974 23,562 26,536 14,289 40,825 89,728
11 89,728 2,355 24,181 26,536 14,289 40,825 65,547
12 65,547 1,721 24,816 26,536 14,289 40,825 40,731
13 40,731 1,069 25,467 26,536 14,289 40,825 15,264
14 15,264 401 15,199 15,600 8,400 24,000 65
    60,636 299,935 360,571 194,154 554,725  
               
Debt Held In Corporation            
  Beginning Balance Interest Principal Loan Payment Tax Payment Total Cash Payout Ending
1 300,000 7,875 26,622 34,497 6,328 40,825 273,378
2 273,378 7,176 27,321 34,497 6,328 40,825 246,057
3 246,057 6,459 28,038 34,497 6,328 40,825 218,019
4 218,019 5,723 28,774 34,497 6,328 40,825 189,245
5 189,245 4,968 29,529 34,497 6,328 40,825 159,715
6 159,715 4,193 30,305 34,497 6,328 40,825 129,411
7 129,411 3,397 31,100 34,497 6,328 40,825 98,311
8 98,311 2,581 31,916 34,497 6,328 40,825 66,394
9 66,394 1,743 32,754 34,497 6,328 40,825 33,640
10 33,640 883 33,614 34,497 6,328 40,825 26
    44,997 299,974 344,971 63,279 408,250  

Closing comments

In closing, who doesn't want "cheap money"?  Take a closer look at your farm debt or stop in to see your lender.  Who knows, you might be able to stretch your farm debt repayments a little further and get the farm un-blistered faster.

 

 

Allyn Tastad, certified general accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at allyn@hth-accountants.ca or website www.hth-accountants.ca. He is also involved in the family farm near Loreburn, Saskatchewan.  The opinions expressed in this column are for information only.