4 Questions To Ask Before Seeking A Farm Loan

As you seek out capital to start your farm business or keep it running, consider these questions to find out of a loan could help.

by Rebeca Kuropatwa
PHOTO: Jay Park/Flickr

While we farmers try to base our decisions on sound judgement, emotion oftentimes plays a big role. The work can be more than you bargained for and the returns aren’t always what you hope them to be. However, when it comes to running a farm business, taking your emotions out of the equation may be the best assurance for success.

“Farming is a long-term time commitment,” says Rick Dehod, farm financial specialist for Alberta, Canada’s Agriculture and Forestry Ministry. “It’s not like you can quit the next day once you made that commitment.”

Committing to your farm dream requires funding, and creating a farm business that is financially sound requires thorough research and obtaining access to capital in a variety of ways, one option of which is business loans. Of course, there are risks associated with any loan, so you must be serious about taking your farm business to the next level.

By working through a business plan, you will have a clearer understanding of your farm business’ challenges and opportunities. You can address the risks and mitigate them. Whether you’re seeking a loan from family or a bank, you will be able to answer their questions and concerns, as well as your own.

Here are some questions to think through when deciding whether farm loans are right for you.

1. How Will The Loan Be Used?

Using all your cash on a down payment on land or equipment will impact your farm’s liquidity and possibly its ability to meet all of your commitments. Before you can get any money back from the farm to make your payment or reap a profit, you need to invest in operating inputs to grow your product, harvest it and market it—only then will you get paid. This could take at least 12 months.

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Loans can be taken out to cover operating costs, to acquire new land, or to purchase needed supplies and machinery. In your business plan, include the size of your acreage, and the types of buildings and machinery you have and need (and whether they’re new or used). Having this information readily available will help you identify how the loan can be incorporated into your business’ budget and your overall business strategy.

2. How Long Do You Want To Borrow Money?

The question of borrowing money is tied to your ability to repay it. Can the farm you are thinking of owning/operating service the additional debt?

“A longer loan amortization with a prepayment privilege may provide less stress on cash flow should margins tighten,” Dehod says. “Agricultural markets are cyclical. Your past income and expenses are a good benchmark for determining your future repayment ability.

“Using this as a base, you can do a projection of what your future income and expenses will be and what your debt service requirement can be. Doing a sensitivity analysis by decreasing your income by 10 percent and increasing your expenses by 10 percent will give you an indication of your repayment risk and your ability to make your payments, should things go not as planned.”

Starting up any enterprise is a risky and, when you add the weather and fluctuating market in an ag business,it could spell disaster and impact your ability to generate revenue. It’s important to include risk-mitigating strategies in your business plan to account for these unforeseen problems that can affect your bottom line.

3. Does Your Business Qualify For A Loan?

“A lot of people think that just because they are passionate about their idea and plan, that someone should lend them the money to pursue their plan,” Dehod says.

What most first time borrowers don’t realize is to access credit, they have had to develop and maintain their credit personality. All financial lenders will request a credit check from a credit bureau, such as Equifax or TransUnion, to see what the borrower’s credit character is. The credit bureaus develop a credit score from the borrower’s past repayment history to determine the likelihood of the borrower repaying the lending contract as agreed.

You can check your credit score at Equifax and TransUnion at any time, so that you know if you’re likely to get access to credit. Even if you’re planning to borrow from a family or friend, while they may not run a credit check on you, they’ll want to know your repayment ability and you past payment performance.

4. Is A Loan Your Most Sound Financial Option?

There are other things you can do to reduce your farm business’ operating costs before you seek out loans. Renting land or leasing equipment are other options that many farmers pursue to lower their demands for capital so they can afford to start a farm.

“Let’s say you’re renting some grain land in your area,” Dehod says. “The average lease cost might be $65 an acre for the grain land, while that acre of grain land might be worth $3,000 to buy. If you take $3,000 times a current 5 percent interest, you’re looking at $150 an acre just in interest costs for the year, never mind your $90 principal payment. So, when you look at the difference between $150 interest minus $65 for land rent, that’s $85 you have available for working capital to pay for your seed, your feed or anything else you require for your farm operation. That can mean the difference of staying in business or exiting.”

While money probably wasn’t a part of your farm dream, careful management of it could be the difference between that dream becoming a reality or just another long-lost wish. Having a sound business plan and knowing all of your financial options will go a long way in helping your farm reach its full potential.

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