Once you’ve identified a plot of land to purchase, the fun really begins. There are plenty of financing options available for farmland but be warned – many of the solutions are significantly more expensive than a home mortgage, and financial planning is essential. We’ll go through the various financing alternatives, as well as how to calculate returns.
There are several farm mortgage providers across the country, including government programs established to help beginning or impacted farmers. Selecting the right loan offering for you can take time – remember that a farm mortgage is a long-term commitment, and you’ll want to be in business with someone you can trust for the long haul.
The U.S. Department of Agriculture (USDA) offers loans through the Farm Service Agency (FSA). These loans are geared toward individuals who struggle to receive loan approval from traditional commercial lenders. FSA’s goal is to provide credit on a temporary basis and help farmers transition to commercial lending.
FSA provides farm mortgages through four types of loans:
- Guaranteed Loan Program: A farm loan is provided by a commercial lender, with the FSA guaranteeing the loan against the lender’s loss, of up to 95%.
- Direct Loan Program: The FSA uses government funds to act as a direct lender.
- Land Contract Guarantee Program: The FSA provides financial guarantees to sellers in exchange for selling farmland to beginning farmers.
- Direct Microloans and EZ Guarantee Program: These loans are direct loans from FSA but for smaller, niche operations.
Most FSA loans max out at $600,000, and microloans max out at $100,000. Because of this and their stricter eligibility requirements, FSA loans are not usually the correct option for established farmers.
Commercial Bank Loans
Most established farmers utilize commercial loans from either Farm Credit banks or other Ag institutions. Farm Credit was created by the government in 1916 to provide credit to rural farmers and ranchers across the U.S. Each Farm Credit institution serves a specified geographic location and is owned by its customers. When you do business with Farm Credit, you buy stock in the institution. You will then receive patronage (a form of dividend) during the life of your loan with Farm Credit, effectively lowering borrowing costs. Farm Credit has well over $300 billion of loans on its books and is available in all 50 states and Puerto Rico.
Several large commercial banks also provide farm mortgages. If you have an existing relationship with any large lender for personal, auto, or home loans, it’s worth asking if they have a farm loan department as well.
Keep in mind that farm mortgages are viewed as riskier investments than home mortgages. As such, rates are significantly higher. An average farm mortgage can be anywhere from 4 – 6% (double a typical home mortgage), and down payments will be 20%+. This is why financial planning is essential.
Another popular option is seller financing, which can be much more flexible than a traditional bank loan. If you already have a personal relationship with the seller, you are in an even better position to negotiate seller financing. Rather than owing the total purchase price at closing, you can negotiate an annual payment plan with the seller over a fixed term, or even negotiate a crop-share arrangement for a longer period. Chat with your seller to see if this is a viable option.
Calculating Borrowing Costs
Most farm loans will have a set Loan-to-Value ratio (LTV) associated with them. This is just as the name implies. A bank will only lend a certain percentage against the total value of the asset. LTV’s typically range from 20 – 40% for farm loans, depending on the total purchase price. For example, a $1,000,000 appraised farm purchase would likely only receive a mortgage of $650,000, satisfying a 65% LTV. That translates to a $350,000 down payment.
Farmland is extremely expensive and because of this, deemed fairly risky. There are protections in place for farmers who miss mortgage payments (including Chapter 12 bankruptcy protection), but of course the goal is to only purchase what you can afford.
Interest Rates on Loans
Farmland interest rates are typically much higher than your average home mortgage rate. Rates can be variable and fixed, and Farm Credit banks provide a 30-year fixed rate mortgage. Those rates are typically in the high 4 – 6% range depending on the creditworthiness of the borrower.
Let’s take a look at an amortization schedule to get a sense of payback on a mortgage.
For our example, let’s assume we’re purchasing a $1,000,000 farm at a 65% LTV on a 30-year fixed mortgage rate of 5.00%. Most banks will offer flexibility for the payment schedule – you would decide on a monthly, quarterly, semi-annual, or annual payment plan. Interest rates may fluctuate depending on your chosen plan. Let’s assume an annual payment plan.
Below, you can see the annual principal and interest payment of the loan.
|Year||Total Payment||Interest||Principal||Ending Balance|
As you can see, a 30-year mortgage on $650,000 at a 5.00% rate results in an annual payment of $42,766.65. That comes out to a ~$1.3m total payment over 30 years for a $1m farm (remember, the mortgage was only for $650,000).
Mortgage calculators, like this one, can be very helpful in planning an amortization schedule and determining the best payment plan. Additionally, being honest with your lender about your financial goals over the term of the loan can help narrow down the options.
Calculating a Rate of Return
We typically use a capitalization rate, or cap rate, to measure the potential cash return of farmland. Since land appreciates in value over time, the cap rate of farmland is always expected to go up.
So what is a capitalization rate? The definition is Net Operating Income / Market Value. Net Operating Income is the annual income on the farm less recurring maintenance fees (property taxes likely being the largest, followed by labor and insurance). The income received on the farm depends if you are an operator or not. If you are an operator, your NOI would include your post-harvest sales less the production and input costs to achieve those sales. As a non-operator, the income in NOI would be the annual cash rent on the farm.
Market value fluctuates but at the time of purchase, the market value would be the purchase price. As time goes on, you can use comparable sales data of recently sold farms in the area to triangulate around a current market value. Formal appraisal services will provide the most accurate sale value but cost money and are not always necessary.
A typical cap rate for farmland can be anywhere from 2 – 6% – a wide range! Farmland is generally a low-return investment, but very dependable.
Return on Asset (ROA)
You might have noticed that the cap rate doesn’t include the debt cost to purchase the farm. This is because the cap rate is meant to reflect the value of the property alone – if one person takes out a mortgage on a farm and another potential buyer wouldn’t require a mortgage, the cap rate would not change because the property itself is the same.
But that means the cap rate isn’t individualized to a buyer and if you are going to take out financing for a farm, you’ll want to know your actual return on investment and how long it will take to recoup your costs. For this, a return on asset (ROA) is very helpful.
An ROA calculation is pretty simple: (Gain on Investment – Cost of Investment) / Cost of Investment.
When calculating an ROA, you would take into account the money you expect to earn on farmland (use cash rent as a proxy as a non-operator), less the cost of the investment. Using a loan calculator, you can see the cost of financing for the period. A tax assessor will be able to provide a tax estimate for the period being examined. You can also estimate insurance costs and any improvement project costs.
The length of time to hold an asset is obviously important for this calculation and highly personal. While some operators wish to keep farmland within the family, others hope to sell upon retirement. Set a timeline that aligns with your financial goals and see the return over time at various purchase prices. This can help set a max budget as you shop.