americanfarmfi, Author at American Farm Financing

Farm Cash-Out Refinance or Farm Equity Line of Credit

americanfarmfi on May 12, 2022

Introduction

As farmland values and inputs rise, sometimes it is necessary to find additional money to fund your farm operation, expand, or purchase new equipment. There are two ways to leverage your farmland real assets to access additional capital to grow your business.

Farm Cash-Out Refinance

It is very common to use a farm loan from a bank to purchase farmland. This type of loan is a mortgage. As you make your payments on your farm, you are lowering the principal and interest on the loan amount. So, as you pay down your mortgage, you are increasing the amount of value that you hold in the farm compared to the amount the bank holds in the form of the mortgage. This is called equity.

If you take good care of your farmland and complete capital improvements as necessary, it is very common for your farmland to increase in value. Real estate value also tends to gain in value over time due to the scarcity of this type of asset relative to the market.

While the value of your farm land increases, you also will experience an increase in the equity of your farm.

A way to access this equity in your farm is to replace your current mortgage with a new one, unlocking the additional value (equity) in your farm. This strategy of getting a new mortgage to access that equity is called cash-out refinancing. Here is an example:

You buy your farm for $500,000 with a mortgage. To keep it simple, let’s assume in 5 years you have paid down $100,000 of your mortgage and your farm value has remained at $500,000. So, you owe your lender $400,000 but you have $100,000 worth of equity built up in your farm. Hypothetically, you could refinance your farm mortgage and now have access to that $100,000 in cash, but now have a new $500,000 mortgage for a new term and interest rate.

You can now use that $100,000 to make capital improvements (install drain tile, buy a new pivot irrigation system, build a grain bin, etc.) or buy a new implement for your farm operation.

Farm Equity Line of Credit (LOC)

Similar to a cash-out refinance is accessing capital in your farm by leveraging the equity with an equity line of credit. Like the example above, you have a farm mortgage at $500,000 and have paid $100,000 in five years. You still owe the lender $400,000 on your mortgage but now have $100,000 in equity in your farm. Instead of refinancing, you work with your lender to open a line of credit that allows you to borrow up to the $100,000 of equity in your farm.

An equity line of credit is useful for those that do not want to get rid of their current mortgage term or rates, but want to have access to the capital in their farm to make improvements to their farm. The line of credit will typically have more flexible repayment structures but the interest rates may fluctuate with the shifts in the market, whereas a mortgage is more likely to have a fixed interest rate for the life of the loan.

Farm Refinance or Equity Line of Credit

If you want to simplify your repayment structure while accessing the equity in your farm, most folks would lean toward a farm refinance to replace their old mortgage with a new rate and payment plan.

Some things to consider when refinancing your farm:

A borrower will be subject to new closing costs and potentially private mortgage insurance.
There are also potentially tax implications related to deductions and credits on your first mortgage compared to the new refinanced second mortgage.

On the bright side, the cash received from refinancing or the equity leveraged in a line of credit are not considered income and are therefore not taxable (currently, the IRS does not tax debt).

Disclaimer: It is always in your best interest to consult a CPA or tax advisor when optimizing your tax liability.

Final Points to Harvest

If you are unsure which strategy is best for you to access your farm’s capital, check out our website at http://americanfarmfinancing.com/.

Ready to refinance? Apply Now.

Understanding Farm Loans and Farm Financing Terms

americanfarmfi on May 9, 2022

Introduction

There are several types of farm loans, including 1) operating loans to fund day-to-day running of the farm, 2) cash rental loans to fund annual farm rentals, 3) farm mortgages to finance the purchase of farmland, 4) farm refinancings to refinance a farm mortgage into a better rate / terms, and 5) term loans to fund equipment and machinery. We’ll dive into each of these farm loan types as well as some farm financing terminology below.

The Farming Cycle

Before we get into each of the farm loans, it’s important to explain why they all exist. Some (like farm mortgages) are self-explanatory: farms are expensive and most folks need a farm loan to make the purchase. An operating farm loan is necessary for most farmers in the Midwest because of the agricultural cycle. For row crops, planting occurs in the springtime (usually from March to May). Harvest occurs from September through Thanksgiving. After harvest, farmers sell their grain, earning their revenue anywhere from September through December. So there’s a big mismatch between when most expenses are made and when revenue is earned. Farmers have to buy seed, new equipment, finance labor, and any fertilizers at the start of the season but won’t make revenue for at least six months. Operating farm loans help provide funding during the first half of the year. Farmers pay off the loan with the revenue earned post-harvest.

The same concept is true for cash rent loans. Cash rent is usually due at the start of the season (March 1st) and can be as much as 40% of a farmer’s full-year expenses.

Operating Farm Loans

Operating loans are typically structured as credit facilities. This means that farmers can draw (or borrow) as much as they need while the loan is outstanding. A typical operating farm loan is signed a month or two ahead of planting season (March 1) and is due back to the bank anywhere from 12 – 15 months later. Usually, a borrower only pays interest on the funds they actually borrow. For example, a farmer could sign a $1m operating loan, but only end up using $800k. The farmer would only pay interest on the $800k borrowed. It’s advisable to create a business plan for the year and apply for a farm loan that would cover unforeseen expenses. That way, it’s easy to access funds as and when needed. It is possible to make an operating loan larger during the season but could just take time to be approved.

Operating farm loans are typically secured by collateral, or property that the borrower owns and the bank could claim if the loan is in default. Collateral can be tractors or even the crops that the farmer grows.

Cash Rent Loans

Cash rent loans are unsecured loans to finance cash rent. Unsecured loans are not secured by collateral. Our cash rent loan has a springing lien, meaning that if the loan is in default, collateral will then be required. This is beneficial for borrowers who do not have to assign collateral at the start of the loan.

Farm Mortgages

Farm mortgages are loans used to purchase farmland. They can be both fixed and variable. Fixed rate loans maintain the same interest rate throughout the life of the loan. Variable rate loans can have a fixed rate for the first months or years of the loan – they will then change rate in line with a pre-determined benchmark. Farm mortgages can be up to 30 years in duration. The longer the loan, the more interest a borrower will pay to the lender – however, the longer term could provide more affordability. A $1m loan spread over 30 years results in smaller annual payments than a $1m loan spread over 10 years.

Farm Refinancings

Farm refinancings are done when better terms are available for a farm mortgage. If a borrower has a 30-year farm mortgage outstanding at a 5.0% rate and rates drop down to 4.0%, a borrower would want to refinance, or change their loan, into the lower rate option to save money. If a borrower also makes more income or has paid off other personal debt, lower rates might be available to them that were unavailable at the time of the original farm loan. Before deciding to do a refinance, a borrower should compare the total savings to any fees to be taken out at the time of the loan.

Farm Term Loans

Term loans are mid-length loans that can be used for more intermediate expenses. Unlike operating loans that cover expenses to be paid off in one year, term loans are usually 3 – 7 years in length and are used to pay for equipment, machinery, and livestock. Term loans have both fixed and variable rates and also use a Loan to Value (LTV) concept.

Farm Loan Fees

Farm loans are subject to similar fees as personal and residential loans. An origination fee is a fee for the bank to originate, or create, the loan. It covers general paperwork and processing. A servicing fee is an ongoing fee to cover the maintenance of the loan. Banks may or may not charge these fees, but it is important to ask at the outset.

For farm mortgages, there will be additional fees for appraisals and title services. An appraisal is an authorized check of value by a bank or a verified third party. The bank will need the appraisal done before originating the farm mortgage. This is to verify that the land will produce income and the loan value is defensible. A title check is performed to ensure that the farm is being sold without debt or obligations attached to it.

How are Farm Loan Fees Calculated?

Farm fees are typically calculated by basis points (bps). A basis point is 1/100th of a percent. In other words, 100 basis points = one percent. A standard origination or servicing fee is 50bps (0.5%) of the loan value.

Appraisals and title checks are usually done for a fixed fee. Appraisals can typically be anywhere from $300 – $1,500.

Conclusion

AFF can help with any of your farm financing needs. Reach out to us at (872) 246-9087 for more on our interest rates and no-fee loans.

Apply Now

Make Your Farm Mortgage Work For You

americanfarmfi on April 26, 2022

Farmland is a unique asset class. It continues to steadily appreciate in value and produces annual cash income. As a farmer, revenue is derived from crop sales. But as a non-operating landowner, annual cash rent can be in the range of 2 – 5% of the farm’s value. And if you’re setting a fair cash rent, your income will increase with commodity prices or inflation.

But as we all know, farmland is very expensive. Farm mortgages are readily available, though an average Loan-to-Value ratio (LTV) is 70% – meaning that a borrower should expect a 30% down payment at the time of purchase. While that’s certainly a hefty price, farmland is worth it, in more ways than one. This article will lay out how to structure a capital-efficient farmland purchase or in other words, how to make your farm mortgage work for you.

Down Payment

While farmland is generally seen as a stable equity investment, lenders have a riskier view. Farmer bankruptcy protections (for more information, see here) are very helpful for family farmers but make it more difficult for a lender to recoup payment on a defaulted loan. And since a farm mortgage could be a second mortgage for folks who already have a home mortgage, it’s seen as a riskier asset. As a result, interest rates on farmland are significantly higher than home mortgage rates (think ~2.0% across all maturities as a frame of reference) and down payments are a lot higher (30% vs a residential down payment of 10%).

These factors can make farmland entirely unaffordable for lots of people. But for non-operating landowners, the annual rent income on the farm could cover a farm mortgage payment each year. This means that the only actual cash to be invested is the down payment. In other words, a landowner could spend 30% of an asset’s value to own 100% of the appreciating asset.

A Real-Life Example

Let’s look at a real example. A 100-acre farm in Illinois is available for sale for $12,000/acre, or $1.2m total. For that purchase value, let’s assume a 65% LTV, meaning a buyer must have 35% available as a down payment ($420,000).

For the remaining farm mortgage value ($780,000), let’s look at a 30-year fixed payment schedule. At a 6.50% interest rate (remember, farmland rates are materially higher than home mortgages), we can expect an annual payment of $59,730.40.

Let’s assume a cap rate on the farm of 4.0% – that means annual cash rent in Year 1 would be $48,0000. This income can offset the annual mortgage payment in Year 1, requiring the landowner to pay only $11,730.40 to service a farm valued at $1.2m.

That still requires a cash outlay from the landowner – but remember that farmland steadily appreciates over time. According to the USDA, over the last 50 years, farmland has appreciated 5.7% annually. So the value of the farm purchased in 2022 ($1.2m value + $48,000 cash rent) could now be worth $1.27m. Keeping the same 4.0% cap rate, 2023 cash rent could be $50,736. By year 5, the farm would theoretically have appreciated enough where annual cash rent would be greater than the mortgage payment. At the end of the 30-year mortgage, the farm could be worth $6m. The entire farm mortgage would have cost just over $2.2m (the $420k down payment plus $1.8m in principal and interest). And assuming a 4.0% cap rate is maintained throughout the 30-year period, the farm would have generated an additional ~$3.6m in cash rent. Excess cash returns over the 30-year period would be roughly $1.4m. For a $420,000 one-time payment, the farm could sell for over $6m. Not too shabby!

Lien Priority and How It Affects Your Operating Loan

americanfarmfi on March 29, 2022

Maybe you’ve heard lenders talk about the lien position they need to take out on your operating loan – first, second, best available. We’ll dive into what these terms mean and how they relate to your farm loan structure.

Farm loans: What is lien priority?

Lien priority is the order in which lienholders get paid out after a default. A lienholder is someone who has a lien, or a right to a payout, following a default.

Secured loans are farm loans that are backed by collateral. For example, a typical mortgage is backed by the property itself. If you default on making monthly payments on your farm, a lienholder would be able to claim the land as collateral.

Continuing with this example, a first lien holder would be the first lender to recoup payment from the land. Let’s look at a practical scenario.

Let’s say you have a $1,000,000 farm, which has a $500,000 mortgage attached to it, which is now in default. If the mortgage-lender is a first-position lienholder (they likely will be), they would be entitled to receive their money back via the farm. The lender would reclaim control of the farm and auction it off, claiming their $500,000 before the rest of the proceeds were divided amongst other lienholders. After the first-position lienholder is paid, the second, third, etc. would get paid. Another lien position, “the best available”, is the lowest lien position available at the time of loan origination. If there are already two lenders, the “best available” lender would take the third position.

Lien priority and operating loans

Depending on the size of your operating loan, your lender may request a lien position against your crop, your farm, or any other available assets. What does this mean for business planning? As a farmer, you need to prioritize which lenders will have the best positions on your assets based on your different relationships.

AFF’s farm loan offerings

We offer operating loans that come with a springing lien. A springing lien takes the best available lien position only after a default. This means that at loan signing, the farm loan is unsecured and would stay that way so long as normal payments are made. We want to free up your collateral so you can use it with other lenders towards other farm improvements. We’re making sure farmers get access to the best capital quickly.

Farm Refinance: Should You Refinance Your Farm?

americanfarmfi on August 3, 2021

Is it a good idea to refinance your farm?

Farm refinance interest rates are coming back down – should you refinance? Like everything in life, the answer isn’t always simple. Most experts recommend refinancing your farm if you can save at least 0.5% on your interest rate. But refinancing isn’t free – you should save enough money to offset the fees (and hold onto the farm long enough to recoup them).

Below, we’ll tackle the basics of the farm refinancing market, what you should look out for, and how to be best prepared to go through with the transaction.

How do I determine if I’m a good candidate for farm refinancing?

Given low rates, landowners can expect to save thousands on refinancing their current mortgages. However, a farm refinance is not for everyone.

If you expect to sell your farm within the next two years, refinancing may not be a healthy option. You likely won’t recoup the costs by the time you sell. Make sure to calculate your breakeven (a handy calculator will help you do so) to see what’s most worthwhile for you.

Generally speaking, a farm refinance makes sense for you if you’re going to be saving on your monthly payments and can accelerate paying off your mortgage. This can happen through any of the following factors:

Interest rates dip at least 0.5% past what you signed
Your credit score has increased, unlocking new rates
You have the opportunity to refi into a shorter-term mortgage while keeping your monthly payments relatively low
You have the opportunity to switch from a variable rate to fixed rate (dependent on how you view market volatility)
You can tap into your farm’s equity for extra cash (more on that later)

If any of the above factors are at play, it could be worth checking your refi options.

What are my farm refinancing options?

Most refis are rate-and-terms, meaning your current mortgage would be replaced with another loan with an amended interest rate or loan terms. The other option is a cash-out refinance, where you can borrow more money than is necessary to pay off your farm. You can use the extra cash to pay off existing debt, help purchase a new farm, or to make any major purchase in your personal life.

What will I need to be ready with?

It takes time to get ready for the refi process! At the minimum, be prepared to provide:

Your credit score and history: Make sure you have no surprises when your lender pulls your credit report. Seeing your credit score and history before choosing a lender can help you determine a fair rate and ensure no errors. You can request a free credit report annually here.
Financial documents: Have your tax returns, pay stubs, bank statements, and sources of other income in hand as you prepare to speak with your lender. We recommend at least two years to get started.
Equity in your farm: Calculating your farm’s equity can ensure you receive the best rates and loan terms. It’s simple: subtract what you still owe on your farm and any existing liens from the farm’s estimated value. If you need help calculating your farm’s value (before an appraisal is done), give us a call and speak with a team member.
Seek out an appraisal or work with your lender to book one: An appraisal will likely need to be conducted for the bank to confirm the value of your farmland. If an appraisal has been done recently on your land, a lender may just use that instead. We can help you with this process – contact us to schedule an appraisal today.
Cash to pay any fees: Fees can be anywhere from 2 – 6% of your loan’s value. The fees could include title, appraisal, attorney’s fees, application and origination fees, and a credit check. Some loan options allow for you to finance the fees (so you would pay them off in monthly installments, along with your mortgage). This could be more expensive, so make sure to calculate which option makes the most sense for you.

How does refinancing your farm impact my credit score?

Unfortunately, farm refinancing will require a lender to perform a hard credit check.

The ultimate effect of a refi on your credit is a bit of a guess. The credit check will affect your FICO score for one year and be displayed on your report for two – usually, the loss from one hard credit check is not too substantial. But because your refinancing is likely taking out a longer-term loan (let’s say a 30-year mortgage) with a shorter-term loan (15-year, for example), the overall length of your credit history decreases, which improves your credit score slightly.

What to be aware of

Bigger ramifications on your credit score can occur from missing a payment on your existing mortgage while setting up your new loan. Be sure to over-communicate with any loan officer and have all your paperwork so you’re on top of all your payments.

When you’re certain you’re moving ahead with a refi, try to limit other major purchases (car, home, additional land), as the frequent credit checks will further harm your score. And if you’re shopping around for rates (you should!), try to complete all credit checks within 45 days, as they would be treated as just one hard check on your score.

If you’re engaging in a cash-out refinancing, the additional debt could hamper your score. If you’re tapping into your farm’s equity in order to pay off extra debt, that could actually improve your credit.

What is a cash-out refinancing?

That brings us to a cash-out refinancing. Let’s say you can refinance your mortgage to $500,000, but could use an extra $50,000 for a home renovation. Assuming your farm is worth at least $550,000, you can borrow against your equity in your farm to take out that $50,000 in debt. Since this increases your overall debt, it can negatively impact your score. However, if the rate is attractive and you’re using the $50,000 to increase equity in another one of your assets (in this case, your home) or paying off credit card or medical debt, the cash-out refi can be really attractive.

The bottom line is, only you know what is best for your financial health and your family’s goals. There are pros and cons to any decision – but be sure AFF is there to help you every step of the way.