The economy is tough, and borrowing costs are on the rise. How will this impact your land loans and your farm’s bottom line?
Since the end of historically low interest rates in 2022, farmers and lenders have adapted to what many call the ‘new normal’ for farm loan rates. This adjustment period has seen some farmers and ranchers pausing their expansion plans.
But you don’t have to let these outside forces stall your progress. While you have little control over the broader markets, you can undoubtedly get the best terms on land loans with the proper knowledge and strategy. This starts with understanding the ins and outs of variable and fixed-rate farm loans. After all, the most innovative way to manage market volatility is to build a solid understanding of all your financing options.
Variable vs. fixed-rate land loans
The US economy has seen its fair share of highs and lows in interest rates over the years. These swings affect whether borrowers lean towards fixed or variable-rate land loans.
What should you do, given the current state of the economy? The right decision should hinge on the current state of interest rates and what you aim to achieve financially. Let’s take a closer look at the different options:
Variable-rate land loans
As the word ‘variable’ in variable-rate land loans indicates, your interest rate isn’t set in stone — it changes over time.
Your rate will instead be adjusted based on market conditions, which means your monthly payments could rise or fall depending on the economy. Expect these adjustments to occur regularly (monthly, quarterly, etc.), anchored to a benchmark like the prime rate or LIBOR.
During the initial period, variable-rate loans typically offer a lower interest rate than fixed-rate loans. However, your monthly payments will vary based on fluctuating rates. If rates climb, prepare for higher payments. If they drop, you’ll pay less.
Why choose a variable-rate land loan?
A variable-rate farm loan might be right for you if you:
- Believe interest rates will stay the same or fall during the duration of your loan
- Intend to sell your land or refinance before a significant rate hike hits
- Are you okay with taking on some risk when it comes to your total debt load
Variable rates and loans can be tempting because of their lower initial costs and the possibility that you might benefit from falling rates. But there is a flip side: They also carry the risk of rising payments if rates go up. Ensure you understand this risk before choosing this type of land loan.
Fixed-rate land loans
Fixed-rate land loans are precisely what their name suggests — they ‘fix’ or lock in your interest rate for the duration of your loan. Once you secure your loan, the monthly payments and interest rates don’t change. This consistency means no guesswork with your budgeting — what you pay this month is what you’ll pay every month until the loan is repaid.
These types of land loans usually range from 10 to 30 years. Depending on your more extensive operational plans, this extended period may help stabilize your farming business by shielding you from unexpected increases and allowing you to plan a long-term financial strategy.
Why choose a fixed-rate land loan?
There are no surprises when you choose a fixed interest rate. Rising market rates won’t affect your loan, and you don’t have to worry about economic fluctuations changing your payment obligations. Knowing that your monthly payment will remain constant throughout the life of the loan can bring you peace of mind, which is invaluable, especially in volatile economic times.
A fixed-rate land loan could be your best bet if you:
- Aim to keep your property long-term and prefer not to refinance
- Value predictability and stability in your financial planning
- Are comfortable managing debt payments at a set rate (even if it’s initially higher)
- Anticipate that interest rates will increase in the future
Choosing a fixed-rate land loan provides the security of predictable payments. These types of land loans also simplify financial planning because they eliminate the risk of rising interest rates impacting your budget.
The third option is adjustable-rate mortgage (ARM) land loans
If you still cannot decide between variable and fixed-rate land loans, there’s a third option: adjustable-rate land loans.
This hybrid blends the benefits of both fixed and variable rates, providing an alternative for those using land as collateral. Here’s a quick breakdown of how these land loans work:
Fixed period (3-5 years)
The interest rate remains unchanged for the first three to five years (depending on your loan agreement). This stable rate period allows you to enjoy predictable monthly payments, which can help you better plan and budget your finances.
Adjustable period (remaining years)
Once the fixed period ends, your interest rate adjusts according to the prevailing market rates. This means that your monthly payments may increase or decrease annually, depending on market changes.
Up to 30-year term
This long-term conventional loan adjusts after the initial fixed period but maintains the same overall term unless you opt to refinance.
Adjustable-rate land loans also often include caps that limit the extent of interest rate changes during each adjustment period and throughout the loan’s duration. These caps provide more predictable limits than those typically found in variable-rate land loans.
Why choose adjustable-rate land loans?
Because an adjustable-rate land loan provides the initial stability of a fixed-rate loan, it blends security and flexibility over the loan’s term. Choosing it could be advantageous if you:
- Intend to refinance or sell the property before the fixed-rate period concludes
- Expect stable or decreasing interest rates
Does your existing loan have a balloon payment (a large lump sum due at the end of the term), or is your interest rate about to reset to a potentially higher level? Switching to an adjustable-rate loan might make sense.
With an adjustable-rate loan, you can often secure a lower initial interest rate and reduce your monthly payments to manage your finances more comfortably, especially if facing a significant balloon payment. The adjustable-rate structure also gives you more flexibility as your financial situation evolves. If interest rates decline in the future, your costs could also decrease.
It’s essential to remember that adjustable-rate loans also carry the risk of rising interest rates. If rates increase, your monthly payments could go up exponentially. This is why it’s crucial to carefully consider your financial situation and risk tolerance before choosing this type of land loan.
An example showing the differences
To illustrate the differences between variable-rate, fixed-rate, and adjustable-rate land loans, let’s imagine a $3 million land loan under each scenario. Here’s how the monthly payments break down for each type of loan based on the initial terms:
Fixed-rate land loan
Loan amount: $3,000,000
Interest rate: Fixed at 4.5% throughout the term
Monthly payment: $15,200.56
This monthly payment stays the same throughout the 30 years.
Variable-rate land loan
Loan amount: $3,000,000
Initial interest rate: Starts at 4% (lower than fixed-rate)
Initial monthly payment: $14,322.46
The monthly payment under this scenario is lower than you would pay on a fixed-rate land loan, but it adjusts annually based on market conditions. To illustrate, if the interest rate rises to 6%, monthly payments will rise to $17,986.52. And if the interest rate rises to 7%, monthly payments will rise to $19,959.07.
Adjustable-rate land loan
Loan amount: $3,000,000
Initial fixed period: 5 years at 3.5% (lower than both fixed and standard variable rates)
Initial monthly payment for first five years: $13,471.34
After five years, the rate adjusts annually based on market rates. To illustrate, if the interest rate rises to 5%, monthly payments will also rise to $17,537.70 (calculated for the remaining 25 years of the loan term). And if the interest rate rises to 6%, monthly payments will go up to $19,329.04.
Note that these calculations assume the loan is fully amortizing (meaning the principal balance decreases with each payment). They do not account for potential prepayment penalties or other loan-specific terms, which can alter the loan’s financial dynamics. However, they are usually not included in the basic amortization calculations. If these elements are part of your loan agreement, consider them separately to fully understand your land loan’s total cost and the financing arrangement’s implications.
Explore land loans with Private Capital Investors.
When times are unpredictable, you need to work with a lender who understands agriculture, listens to your plans and goals, and can tailor a solution that helps you achieve your goals.
Private Capital Investors can help you establish a stable financial foundation in an unstable market by offering various financing options, from conventional to alternative.
Explore our range of land loans, and don’t hesitate to contact our team of private commercial real estate lenders to discuss your project. We’re excited to help you build a sustainable and prosperous farming operation.
