Longer Repayment Terms, More Payments
Earlier this summer, we noted that, despite higher interest rates, longer repayment terms kept annual debt payments historically low. However, longer repayment terms mean more payments. Consider the following farm machinery and equipment debt data reported by the Kansas City Federal Reserve Bank:
- In 2021, the average interest rate on farm machinery loans was 4.2% over 43.1 months. The monthly payment on $1,000 of debt would be $25.
- In 2022, the average interest rate on farm machinery loans was 5.4% over 44.0 months. The monthly payment on $1,000 of debt would be $25.
Over the life of that $1,000 farm loan made in 2021, the total interest expense would be $79. However, the total interest expense for the same $1,000 loan made in 2022 would be $104. While reality often isn’t this clean-cut, this case perfectly illustrates how one additional monthly payment affected the total interest expense (32% increase) but also didn’t change the monthly payments.
Reviewing Interest Expense Trends
To consider the interest expenses accrued over the lifetime of a loan, we created the Interest Expense Index (Figure 1). There are a few surprises. First, the interest expense on $1,000 of farm machinery debt during the 1980s was not at record levels. This was because repayment terms were short, often less than a year.
Second, loans made in the first quarter of 2023 had a lifetime interest expense of $158. This is nearly double the levels observed in recent years (often around $80) and higher than a condition in the 1990s.
Wrapping It Up
Higher interest rates make debt more expensive. What’s not always clear is how, exactly, higher rates affect producers. For instance, extremely high rates in the 1980s occurred with short repayment terms, a combination that resulted in extremely high annual debt payments. More recently, however, the upturn in interest rates has occurred with historically long repayment terms. This has resulted in higher interest expenses being felt through additional payments.
Due to moderately high rates and extremely long repayment terms, those borrowing $1,000 in farm machinery debt today will have the highest total interest costs observed in over 50 years. The effect of this trend could linger for several years.
Finally, in a related AEI Premium article, we dug into how longer repayment terms can lock producers into future cash flow obligations, making it harder to create wiggle room during a Margin Squeeze with less income and cash flow to work with.
In conclusion, longer repayment periods have been a largely overlooked trend in farm debt and come with the trade-off of lower annual payments but more months of interest accruing and commitment.