Farm mortgage strategies
Consider these tactics to reduce interest rate risk and pay down the mortgage sooner.
From where Rod Gardner's sitting, the farm mortgage business has rarely been busier. As RBC Royal Bank's regional manager for mid-western Ontario, he saw acres and buildings change hands in 2004 at an unusually brisk pace. He cites several factors at play.
"We're seeing a continued transition between generations," he says, "as well as the ongoing consolidation among large-scale commercial farmers, and the growth of lifestyle farms being purchased by city people."
How are buyers setting up their mortgages these days? Are they concerned about the possibility of rising rates? Which terms look most attractive? In Gardner's view, experienced, well-capitalized producers are choosing mortgages that achieve several objectives.
1. Fuel the farm's business plan. When Gardner and his RBC Royal Bank colleagues write farm mortgages, they have the same long-term outlook as their clients. "Our clients tend to have a very clear view of where they want to take their farm," he says. "So a mortgage is more than a one-time transaction. We'll consider the client's five-year plan, and set up the mortgage in line with the farm's future expansion plans."
2. Protect against rising rates. The jury's still out on the likely direction of interest rates in Canada. As noted on page 8 of this publication, RBC Royal Bank's economists believe that further increases are unlikely until the end of 2005. Even so, this is an area where Gardner encourages clients to think defensively.
"We analyze the interest rate that a business can tolerate," he says. "If the operation would be hardpressed to weather a 2% to 3% interest rate shock, then we'll recommend they lock in for three to five years."
3. Go deep on principal payments. Many farms have the ability to generate surplus cash, over and above the immediate needs of the farm and family. In this case, producers like the option to prepay their mortgage principal.
Gardner often recommends a strategy that allows producers to enjoy low rates through a variablerate mortgage, while making principal prepayments more or less automatic.
A payment schedule can be established in which the payment is set a bit higher than current rates would dictate. For example, rather than paying Prime-plus-1% – that's 5.25% at time of printing – a producer might pay 7%. The effect is that the producer is making regular installments on a prepayment of the mortgage.
"This is a very common strategy to allow the customer to take advantage of the variable rate," says Gardner, "but also build a prepayment into their payment schedule."
4. Finance the whole purchase. A mortgage should be amortized based on the useful life of the asset. In the case of land, a 25-year mortgage used to be standard. Gardner now finds that 20 years is often the longest duration that farmers want, since its payment is only marginally higher than with a 25-year amortization.
In intensively farmed southwestern Ontario, farm purchases involving only land are becoming more rare. Almost always, buildings and other assets are included in the transaction. RBC's RoyFarm Mortgage® is popular for this very reason. With its Multiple Loan Option, producers can divide their mortgage into a series of smaller loans: one for land, one for buildings, one for quota, for example. Each loan within the mortgage can have different interest terms, payment frequencies and amortization.
"We also see many producers taking advantage of the re-borrowing option," says Gardner. "As the mortgage is paid down, this mortgage lets you re-borrow up to the original amount, without doing new paperwork or legal work. It's a great fit when a producer is looking several years down the road."
For more information on the RoyFarm Mortgage, or for advice on financing a farm purchase, contact your RBC Royal Bank farm finance specialist.
|
