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Interest Rate Update

Fixed- versus variable-rate financing

Published on 6/12/2020

Interest rates have a significant impact on producers’ borrowing costs and investment decisions, including their machinery purchases. Deciding when to invest, how much to invest in and whether to finance with a fixed- or variable-rate largely depends on risk tolerance.

“In years where interest rates have gone down like in 2019 to 2020, producers have fared well with variable-rate financing and benefited from interest rate savings,” says Chris Steinkamp, Iowa AgDirect territory manger. “Whereas in the ‘80s, producers didn’t really have many fixed-rate options, and variable-rate financing took on a connotation of financial risk.”

Forty years later, interest rates have improved but continue to fluctuate. That’s why it’s important to weigh the potential risks and rewards of fixed- versus variable rate financing when making machinery purchase decisions.

Evaluating rate options

Producers have more incentives to invest when interest rates are low. While fixed-rates guarantee consistent payments throughout the duration of the loan, they are generally higher than the initial starting interest rate on a variable-rate loan.

In contrast, by opting for a variable-rate, producers can take advantage of a lower payment in the short term, but carry the risk of a sudden rate increase. However, the likelihood a variable-rate loan spiking above the overall price of a fixed-rate loan during a typical financing term remains relatively low.

In the hypothetical example below, Steinkamp shares how an average five-year variable-rate program would net a lower overall payment than a five-year fixed-rate program.

“If you take a $50,000 loan for 5 years at a 3.99% fixed and 5 years at 2.99% variable rate with variable rate going up .25% every 4 months, it goes from 2.99% to 6.49% and it’s still cheaper than taking that fixed rate out of the gate,” he says. “That gets a lot of farmers’ attention.”

Fixed vs Variable Rate Comparison (Hypothetical Example)

5yr loan, 3.99% FIXED rate

Event

Date

Amount

Loan

06/01/2020

50,000.00

Payment

06/01/2021

11,246.14

Payment

06/01/2022

11,246.14

Payment

06/01/2023

11,246.14

Payment

06/01/2024

11,246.14

Payment

06/01/2025

11,246.14

Total of Payments

56,230.70

5yr loan, 2.99% Variable, increasing .25% every 6 months

Event

Date

Rate

Amount

Total of Payments

 

 

55,891.38

Loan

06/01/2020

50,000.00

Rate Change

12/01/2020

Rate: 3.240%

Rate Change

06/01/2021

Rate: 3.490%

Payment

06/01/2021

11,045.78

Rate Change

12/01/2021

Rate: 3.740%

Rate Change

06/01/2022

Rate: 3.990%

Payment

06/01/2022

11,138.13

Rate Change

12/01/2022

Rate: 4.240%

Rate Change

06/01/2023

Rate: 4.490%

Payment

06/01/2023

11,204.55

Rate Change

12/01/2023

Rate: 4.740%

Rate Change

06/01/2024

Rate: 4.990%

Payment

06/01/2024

11,244.70

Rate Change

12/01/2024

Rate: 5.240%

Payment

06/01/2025

11,258.22

**Hypothetical Example - variable rate could change more or less during term of loan**

Other considerations

Other factors to consider when choosing between fixed- vs. variable-rate financing include borrowing capacity and term length.

“When I talk to producers who are teetering on what type of rate to finance with there are two questions I always ask,” says Steinkamp. “Do you trade frequently, and do you plan to pay off the loan early?”

“If the answer to either question is yes, and you aren’t planning to reach the full term of the loan, that can make variable-rate an appealing option,” he says.

Another instance where variable-rate could be favorable includes producers who put equipment purchases on their line of credit. If the interest rate on the line of credit is higher than the variable-rate, then the variable-rate might be the better option for preserving borrowing capacity and also terming out the debt to help with working capital and repayment capacity.

“With AgDirect, producers also have the ability to convert from the variable-rate to the current fixed rates available at the time of conversion for the remaining term of the note for no fee,” Steinkamp adds. “For some, this might be a selling point knowing they have the option to switch if they are willing to take on some initial risk with a variable-rate.”

To learn more about AgDirect rates and financing terms, contact your nearest AgDirect territory manager or the AgDirect Finance team at 888-525-9805.

Learning Center

Agriculture is constantly evolving, which is why AgDirect® works to help you make the right decision for your operation when it comes to financing your next tractor, combine or ag equipment.


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