Is interest-only financing right for your operation?

Interest-only financing isn’t for everyone, but it certainly shouldn’t be dismissed out of hand. The interest-only term loan option, where borrowers pay only the interest without reducing the principal, has proven to be an effective financial strategy. This approach has been advantageous due to the consistent rise in farmland values and historically low interest rates over the past. It doesn’t apply to traditional lines of credit or operating loans.

“Interest-only financing has been a popular and effective tool for farmland buyers over the past couple of decades, but it’s not without risks,” says Tim Hammond, president and CEO of Hammond Realty.

Those considering interest-only financing need to be aware of the risks and benefits:

Risks

Hammond says interest-only loans have worked well in a rising land market, but they come with notable risks:

• Rising interest rates: “With rates higher than they’ve been in years, the cost of carrying these loans can increase significantly, putting strain on cash flow,” Hammond says.

• Flat or declining land values: If values stabilize or drop, farmers relying on appreciation could be left with little equity and a higher risk profile.

• Equity challenges: “Without reducing the principal, borrowers aren’t building equity, which can make it harder to secure future financing,” Hammond says.

“The business may then find itself in a higher leverage situation than it intended, resulting in reduced creditor support, higher costs of credit, credit restrictions, higher creditor monitoring, etc.,” adds Denise Filipchuck, farm management consultant with Filipchuck Management.

Benefits

Despite the risks, interest-only loans do have a place for some farmers and in certain situations.

Interest-only loans can be helpful during farm transitions.

Filipchuck says interest-only loans can be helpful during farm transitions when young farmers start out on their own or during a large expansion of an existing and well-established operation. “Have a strong business plan in place with ongoing financial and strategic planning and monitoring,” she says.

Hammond highlights flexibility as the main advantage of these loans, helping farm operators manage cash flow while pursuing growth and funding daily operations or upgrades.

Interest-only financing lowers the upfront financial barriers to making purchases, he notes. It can also help a farm operator act fast when the right piece of land comes up, Hammond explains.

Such loans provide short-term strategic benefits as well. “Many farmers use these loans as a bridge, intending to refinance or pay down principal later,” Hammond says.

Tax benefits exist, and interest payments are tax-deductible, he says.

Interest-only financing can be a valuable tool under the right circumstances, but success depends on careful planning, financial monitoring, and a clear understanding of its risks and benefits.

From an AgriSuccess article by Richard Kamchen.