Six tips to help cut a deal with your banker
The banker has all of the power when it comes to a loan, right? Wrong, says Michael Boehlje, Purdue University agricultural economist. "Approach your lender as an equal, because you are," he says. "You don’t have to beg for money."
In Boehlje’s view, successful farmers are highly desirable customers and have more power in negotiations with lenders than they might imagine. It’s important to take the time to compare rates, terms and other parts of the deal with a handful of lenders before signing on the bottom line.
"Applying for a loan can be intimidating," Boehlje acknowledges. To make the process as systematic as possible, he has identified six areas of negotiation for farmers to address:
1. Loan amount. While farmers need to be cautious about borrowing too much, since it all has to be paid back with interest, they frequently don’t borrow enough. As a result, they can put themselves in the awkward position of having to go back and ask for more. That is not a good situation to be in and puts farmers at a bargaining disadvantage.
"Many farmers are not as careful as they might be in making projections," Boehlje says. "They don’t do their upfront forecasting work. Don’t lowball what you truly need."
2. Rate. While it pays to shop around, rates from lender to lender are fairly competitive. Overall, Boehlje says, interest rates are at historic lows—which means rates are more likely to go higher than lower. It’s worthwhile to check into switching from variable- to fixed-rate financing, particularly on longer-term loans.
3. Term of loan. Many farmers have an aversion to debt. As a result, they box themselves into shorter loan terms and don’t give themselves a cushion if costs exceed projections or returns are lower. It often makes more sense—say, on a tractor loan—to obtain a four- to five-year loan than a three-year loan. When buying land, a 20-year loan instead of a 15-year note is ideal.
"Don’t reduce your flexibility on the downside," Boehlje advises. "Too short a term puts unnecessary cash flow pressure on you."
Make sure you get a loan with no prepayment penalty, so you can make early payments if you have the cash.
4. Refinancing potential. Discuss with your lender what he might be willing to do if a building or expansion project doesn’t go as planned.
"It’s better to have the discussion about a possible refinancing or deferral of a principal payment upfront," Boehlje says.
5. Collateral. Lenders want to be fully protected in the event things go sour. While this is a sensitive area, farmers should still negotiate the terms, Boehlje says. Try to avoid personal guarantees; don’t pledge personal property as well the farm business as collateral.
"In some cases you may have to sign a personal guarantee, but it should be part of the negotiation," Boehlje says.
6. Covenants. Some lenders want to draft a covenant before a loan is approved that specifies, for example, that capital expenditures can’t be made without lender approval. Read through the terms of the covenant carefully, Boehlje says. If you sign and violate the covenant, the lender can call in the note.
Keep Funds Separate
It’s important to have a separate hedging loan line that can be used in the event of margin calls for futures and options, advises Michael Boehlje, Purdue University economist. "You need to know what your upper limit is prior to hedging," he notes. "The advantage of a separate credit line is that farmers won’t put themselves in a position where they have used their line of credit for margin calls and don’t have funds for planting the crop."