Financing your Small Farm
"Before you ever think about financing, check on your credit history," Carla Green of Mid-Atlantic Farm Credit advised a packed room of about 60 workshop participants during the "Breaking the Barriers -- Access to Land, Capital and Equipment for Farm Start-ups" workshop held March 20th at Penn State's new Lehigh Valley Campus in Center Valley. The sold-out workshop was co-sponsored by Penn State Cooperative Extension and the Pennsylvania Department of Agriculture.
That includes checking your credit history with all three of the major credit-reporting agencies -- Experian, Equifax and TransUnion -- she said, adding that the information can be accessed one time annually free of charge, but that this service will not include an actual credit score. Green, who specializes in small farm financing, also advised that scores "purchased" online do not always accurately reflect what the bank sees when it pulls your credit history. (See further resources below.) "Stuff shows up on your credit report that you don't know -- medical stuff ... mistaken identity," she said. "It's good to make sure your credit report is as clean as it can be before you even think about going for a loan."
The type of financing you apply for will depend on the type of farm you are going to buy as well as your needs and circumstances, Green said. If it's going to be a full-on business, then that will require business financing and at least a rudimentary business plan, which she said should include:
- All income streams, such as stall rent (X number of horses at Y dollars a month each), ground or barn rental, X acres of corn at Y bushels per acre at Z price, etc.
- A thorough expense sheet.
- A brief narrative that describes your farm business plan and your experience to carry it off.
- Any existing business or "projected income" that will remain (it helps to have obtained the seller's tax return to validate actual revenue history).
A business plan that shows income will strengthen the loan application, Green said. "It's helpful to have written down very specifically how that income was developed -- board, lessons, etc. -- and to list expenses. Banks look at the net ... your income minus the expenses," she said. "We're looking at that bottom line."
If you're looking at a modest-size farm -- say 10 or even up to 20 acres with a house and a barn -- and especially if you have off-farm income, Green advised that it might be cheaper and easier to go for a residential rather than a business loan. Currently [spring 2010], she said, this type of loan is available over 30 years at a fixed rate of about five percent. The main stipulation with these types of loans is that they must contain a primary residence.
Unlike business loans, projected income won't help you qualify for residential loan and certain debt restrictions, credit rules and loan limits apply depending on the lending program. "There are a lot of pros and cons with different kinds of financing," Green said. "Don't disregard residential financing, because it's a cheap way to go. Farm financing is a business loan, and it can get expensive. There are not a lot of grants out there for purchasing farming businesses."
Different types of farm loans are set up for different types of farming operations, Green said, including:
- Operating loans, usually provided as a line of credit to be paid back (typically at Prime rate) once the farmer receives revenue -- such as for a crop.
- Term loans for infrastructure and building improvements. Here, most banks match the length of the loan to the projected depreciation value or life expectancy of the purchase, Green said. For instance, financing for a used tractor might be for a three to five year period, while payback for a loan for construction of a new pole barn might span ten years.
Government-sponsored term loans typically mean low rates, but high transaction fees and, Green suggested, only make financial sense when the loan amount is quite high (over $500,00). These programs include:
- EDC (Economic Development Council) loans for machinery, equipment and land purchases.
- FSA (Farm Services Agency) loans, which can assist farmers who have been denied conventional loans [at the time of the workshop there were no funds available in this program].
- Pennsylvania Department of Agriculture (PA Grows).
All of the about have allocations attached to them, Green said, and when that allocation is used up the programs are put on hold at least until the next budget cycle.
Mortgage loans are typically for the purchase or refinancing of real estate, Green explained, with terms typically spanning 10 to 30 years. She reiterated that residential loans are always cheaper and easier to obtain than business loans and suggested this is indeed the way to go if the farm is being purchased primarily for residential purposes with farming as a sideline. If the farm is residential, but also commercial -- e.g., the loan will be paid back from farm-operation revenue -- then the loan is considered commercial, Green said, adding that while these loans can go up to 30 years their more typical lifespan is 20. Required money down for these types of loans is generally 20 percent, she said, adding that both EDC and FSA help service these loans.
A good rule of thumb for figuring how much a loan will cost a borrower in the long run is to consider that a 20-year loan will roughly double the initial cost of that loan -- in other words an initial $100,000 loan will ultimately cost the borrower $200,000 -- while a 30-year payback will approximately triple that amount. While the actual math will fluctuate with interest rates, the above gives a pretty good example of the differences in actual costs associated with typical mortgage loan life spans, Green said, also suggesting that borrowers should be wary of terms that include penalties for early repayment.
When it comes to loans for farming operations, many choices exist with an even greater number of nuances, Green said. "You must have money down to buy a farm," she said. "With Fannie Mae you can buy a farmette with as little as five percent down -- You can't get mortgage insurance at that rate, but you can get it if you put ten percent down. Farm Credit says that at 15 percent down I can get a loan, but not at 30 years. What the bank does is say, "This will work with this cash flow, but we're going to put him on a 20-year or a 15-year loan, because the principal will be paid back quicker and there's less risk to the bank."
Cash is king, Green suggested. "It's not only important for money down, but after closing stuff goes wrong -- the tractor breaks down or it doesn't rain or some other event -- and you have to have money to keep your operation going." The more you can demonstrate to the bank that you not only have a solid business plan, but that you aren't stretched so thin that you can't deal with a rainy day -- or lack thereof, as the case may be -- the more likely banks are to do business with you, she said. "We look at the five Cs [character, capacity, collateral, capital and conditions] just like everyone else."
Farm loans are not "cookie-cutter" loans, Green advised, and each one takes time to analyze. Come prepared with your own ducks in a row -- including tax returns, pay stubs, solid numbers on your assets and liabilities, and even retirement account information (which are assets and can, therefore, be borrowed upon, she said) -- and be prepared to leave plenty of time for your financial institution to do its own work to ensure a win-win match. "Everything is different," Green said. "We do a lot of work for each loan."
By Dan Sullivan