Considering The Interest-Only Credit Line: How Long Will That Good Deal Stay Good?
One of the options available to farm owners who need loans is the long-term interest-only loan, in which you make payments that cover interest for a few years before switching to traditional interest-and-principle payments. These can be a great way for someone to get into farming without breaking their budget as the farm gets underway. However, for people who were stung by bad mortgage loans in the Great Recession, "interest only" sounds familiar and possibly alarming. Is that really the case? Not quite, but you do need to be careful about what you agree to in order to get a good loan that helps you.
Variable vs. Fixed Interest
In interest-only periods, you pay only the interest that accrues each month. Eventually, the payments will jump in size when principle is included. Here's the issue: You need to know what the interest rate will be when principle payments start, and you need to make sure the rate is fixed.
A large part of the problem with those aforementioned mortgage loans was that they were adjustable rate, and that rate caused payments to soar. While the loans weren't necessarily interest-only at first, people started out paying a very small, fixed amount for a set amount of time, with the agreement that at a particular point, the payments would change as the loan interest rates changed to whatever the goind interest rate was. For many people, that meant the payments suddenly increased in size by a large amount.
For farm financing, paying interest only for a while might not be exactly the same, but the idea of payments jumping up later could bring about a similar situation in which payments become unsustainable.
Make sure your interest rates are fixed and be doubly sure of what your monthly payments will be each year. Do not leave anything up in the air or at the mercy of the market.
Lower Initial Payments vs. Longer Time to Pay Off
Those interest-only payments will be very low for a long time. That gives your farm a chance to get going and hopefully earn some money. But that also means your loan will take a much longer time to pay off. If you're willing to deal with that longer time, then interest-only could be a good introductory loan payment plan for you.
No Compounding vs. No Reduction in Principle
You're paying all the interest each month, so you won't have a growing, compounding loan. That's good! But you also won't be reducing the principle, which is why the loan will take longer to pay off. Just be sure you realize that your initial payments will go to keeping the loan the same size, not reducing it.
You can find great interest-only loans for your farm. Just keep an eye on the terms and never leave anything unanswered -- ensure all payment amounts and terms are in writing.