Should you choose fixed or variable rates?
Interest rates in Canada are on the rise for the first time in seven years. The Bank of Canada increased its key interest rate by 25 basis points in January 2018, and two times previously by 25 basis points (in July and September of 2017), resulting in a 1.25% rate. The upward trajectory has producers wondering whether it’s time to lock in a fixed rate on at least some of their loans.
“We are asked all the time whether a producer would be better off going with a fixed or variable rate loan,” says J.P. Gervais, Vice-President and Chief Agricultural Economist with Farm Credit Canada. “Floating interest rates have worked for farmers for many, many years, because the long-term charts show that interest rates have been declining for 30 years. But just because the rates have been trending down, there’s no guarantee they will remain this low forever.”
Even if the Bank of Canada continues with some small rate increases, producers shouldn’t view it as something to be alarmed over, Gervais says. The increase to 1.25% only brought rates back to where they were in 2015 before being adjusted downwards to help the economy adjust to the slowdown in the oil and energy sector.
Ask yourself how an interest rate increase would change your margins next year, Gervais suggests. Is your working capital optimal should you face tighter margins? How would it change your long-term profitability? Use this increase as an excuse to look at where you stand in your balance sheets.
Whether you switch to a fixed-rate loan or let it float ultimately comes down to your tolerance for risk. If you’re comfortable with the level you have, there isn’t any reason to fix anything. However, if you’re highly leveraged, you might come to a different conclusion.
What's your comfort level?
“Nobody knows where interest rates are going to be in a couple of years,” Gervais says. “Some people will decide they don’t want to worry about interest rates on top of production risk, price risk and the other worries they face, and will lock in their rates for five years. Others will reduce their risk by taking a fixed rate on their next loan. It all comes down to what producers are comfortable with.”
Some small increases aren’t a sign the long-term trend towards low interest rates is reversing, Gervais says. However, it does give producers a good reason to sit down with an accountant or financial advisor and discuss how a one or two per cent increase in borrowing costs would impact their operation.