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Fixed- versus variable-rate financing

Fixed- or variable-rate financing: What’s best for you?

Published on 9/24/2015

Though it’s three decades gone from today’s rural economy, the farm crisis of the 1980s remains fresh in a lot of grain and livestock producers’ minds. And while farm balance sheets have long since recovered, that decades-old financial crunch continues to be a factor in some farm financing decisions.

Especially in the big-ticket financing arena for farm machinery – financing a large tractor or combine, for example.

Variable-rate financing still carries a connotation of “financial risk,” making fixed-rate financing a foregone conclusion for some producers. But, today’s rate environment makes variable-rate financing a viable option, some say more so than fixed-rate financing as interest rates remain generally low.

It all boils down to your risk tolerance and aversion, says AgDirect territory manager Chris Steinkamp. “The ‘80s put a stain in people’s minds. If I talk to a guy who went through the ‘80s, the first thing out of his mouth is ‘I don’t want variable,’” he says. “It’s a once-bitten, twice-shy kind of deal.”

Fixed and variable options

Though fixed-rate financing adds slightly to the overall cost of a machinery purchase right now, it does offer the security and comfort of an unwavering interest rate – something typically of higher value if you “lived through the ‘80s.” Variable-rate financing leaves the door open to fluctuations, and right now the deck is stacked in favor of a rate increase.

On the other hand, variable-rate financing has unique advantages right now. Though rates could rise, the likelihood that they’d shoot high enough during the typical financing term for a large piece of farm machinery to push a variable-rate loan above a fixed-rate loan in overall price remains fairly low.

Steinkamp says an average hypothetical five-year variable-rate program would still net a lower overall payment than a five-year fixed-rate program right now.

“If I take a $100,000 loan for 5 years at a 3.95% fixed and 5 years at 2.5% variable rate and I’ve got that variable rate going up a quarter every 4 months, it goes from 2.5% to 6% 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, 3.95% FIXED RATE

Event

Date

Amount

Loan

03/01/2015

100,000.00

Payment

03/01/2016

22,468.59

Payment

03/01/2017

22,468.59

Payment

03/01/2018

22,468.59

Payment

03/01/2019

22,468.59

Payment

03/01/2020

22,468.59

Total of Payments

112,342.95

5YR LOAN, 2.50% VARIABLE, INCREASING .25% EVERY 4 MONTHS

Event

Date

Rate

Amount

Total of Payments

 

 

111,687.27

Loan

03/01/2015

100,000.00

Rate Change

07/01/2015

Rate: 2.750%

Rate Change

11/01/2015

Rate: 3.000%

Rate Change

03/01/2016

Rate: 3.250%

Payment

03/01/2016

21,913.57

Rate Change

07/01/2016

Rate: 3.500%

Rate Change

11/01/2016

Rate: 3.750%

Rate Change

03/01/2017

Rate: 4.000%

Payment

03/01/2017

22,202.81

Rate Change

07/01/2017

Rate: 4.250%

Rate Change

11/01/2017

Rate: 4.500%

Rate Change

03/01/2018

Rate: 4.750%

Payment

03/01/2018

22,414.66

Rate Change

07/01/2018

Rate: 5.000%

Rate Change

11/01/2018

Rate: 5.250%

Rate Change

03/01/2019

Rate: 5.500%

Payment

03/01/2019

22,548.05

Rate Change

07/01/2019

Rate: 5.750%

Rate Change

11/01/2019

Rate: 6.000%

Payment

03/01/2020

22,602.18

**AgDirect offers customer option to convert variable rate to whatever the fixed rate is for remaining term of note at the time of conversion for NO FEE.**

Risk tolerance is critical

That hasn’t always been the case. When the last recession hit in late 2007, it set off a period when fixed rates were sometimes below variable rates. Today, however, a “bigger spread” between fixed and variable rates has developed, making the latter a lower-cost option in many cases if you have the risk tolerance to accept the potential for a rate increase.

Financing big-ticket machinery with AgDirect, for example, can preserve your bottom line from erosion if and when interest rates do begin to climb through an adjustment to a fixed-rate program. And, in the long run, this type of variable-rate program with the option to lock in a fixed rate helps the dealer strike a more harmonious chord with his or her customers.

“If the rate goes way up with a variable product, you can pick up the phone and call AgDirect. The risk is whatever the fixed rate’s going to be at that time,” Steinkamp says. “Dealers should be looking to offer the most lucrative deals to farmers to get their attention.”

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 ag equipment.

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