What to do when the in­ter­est rates are so high

Prairie Post (West Edition) - - Agriculture -

In view of ris­ing in­ter­est rates, an is­sue that may come up dur­ing mort­gage loan term ne­go­ti­a­tions is whether to lock into a fixed long-term mort­gage rate or stay in a vari­able rate. Dean Dyck, farm busi­ness man­age­ment spe­cial­ist with Al­berta Agri­cul­ture and Forestry looks at the fac­tors to con­sider.

“Know­ing your in­ter­est costs and your farm’s sen­si­tiv­ity to an in­ter­est rate in­crease is a good start,” says Dyck. “Should farm mar­gins change, and weather events hap­pen, it is im­por­tant to fig­ure out in ad­vance whether the farm’s loan re­pay­ment ca­pac­ity can han­dle a 2, 4, or 6 per cent in­crease in in­ter­est rates.”

Debt ser­vic­ing anal­y­sis is bro­ken down into two main sec­tions – debt ser­vic­ing ca­pac­ity (DSC), and debt ser­vic­ing re­quire­ments (DSR). These are cal­cu­lated as fol­lows:

• DSC is ac­crued net farm in­come + de­pre­ci­a­tion ex­pense + in­ter­est ex­pense + off-farm in­come – fam­ily with­drawals – farm in­come tax paid.

• DSR is the to­tal ac­crued in­ter­est ex­pense + to­tal term loan prin­ci­pal pay­ments (for a fis­cal year).

“The dif­fer­ence be­tween DSC and DSR must be pos­i­tive,” says Dyck. “Once you have done the cal­cu­la­tions us­ing cur­rent num­bers, see if the farm can with­stand an in­ter­est rate in­crease of two per cent. Add two per cent to your av­er­age in­ter­est rate on all of the farm’s debt to cal­cu­late the to­tal ac­crued in­ter­est ex­pense. Then check to see if the dif­fer­ence be­tween your DSC and DSR is still pos­i­tive, or if the in­crease in in­ter­est rate sig­nif­i­cantly changes your re­pay­ment risk.”

Lenders often use a debt ser­vic­ing ra­tio (DSR) cal­cu­lated as DSR = DSC / DSR. In­dus­try bench­marks for this ra­tio vary from one fi­nan­cial in­sti­tu­tion to an­other, but gen­er­ally, the fol­low­ing bench­marks ap­ply:

• Greater than 1.5 is low risk.

• To 1.5 is medium risk.

• Less than 1.1 rep­re­sents high risk. “Re­mem­ber, in­ter­est rates are part of your in­ter­est ex­pense cal­cu­la­tion, and your in­ter­est rate does not show up on your in­come and ex­pense state­ment,” says Dyck. “The other part of the cal­cu­la­tion of in­ter­est ex­pense is what you owe. If, in the short run, you have

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