Farm Machinery Loans: Interest Rates and Loan Maturity

Posted by David Widmar on May 13, 2024

One of the more peculiar trends in farm financing is that the effects of sharply higher interest rates were somewhat offset by longer repayment periods. However, more recent data reveal that repayment periods have started to fall, pushing annual loan payments higher.

Interest rates and loan maturity

In the first quarter of 2024, the average interest rate on farm machinery was 8.14%, the highest since 2007 (Figure 1). More recently, first-quarter rates were 92 basis points higher than a year before and 424 basis points higher than two years ago. In fact, rates were 3.9% in Q1 of 2022, meaning rates more than doubled in just two years. Things changed quickly!

 


Figure 1. Annual Average Interest Rate on Farm Machinery Loan (1977-2023, Q1 2024). Data Source: Kansas City Federal Reserve Bank.

 

The second trend has been that the maturity of farm machine loans has been extended over time (Figure 2). The average for all of 2022 was 44 months, but the quarterly data went as high as 53.8 months. While historically higher in early 2024 (37.6 months), repayment periods have contracted over the last year.


Figure 2. Annual Average Maturity of Farm Machinery & Equipment Loans, (1977-2023, Q1 2024). Data Source: Kansas City Federal Reserve Bank.

Farm machinery debt service index

To reconcile the effects of changing interest rates and loan maturities, AEI built and updated the Farm Machinery Debt Service Index (Figure 3). This measure captures the annual payment for each $1,000 of farm machinery debt. Since 2000, the Index has averaged $453 but ranged from $287 to $828. The low was in 2020 when interest rates were at a low of 4.78%, and loans matured after 46.7 months.


Figure 3. Annual Farm Machinery Debt Service Index – Annual Payment to Service $1,000 of Debt (1977-2023, Q1 2024). Data Source: AEI.ag

One challenge with these data is seasonality. To account for this, Figure 4 shows the index value for the first quarter between 2015 and 2024.

In Q1 of 2024, loan terms were 8.14% for 37.6 months. In Q1 of 2023, terms were 7.23% for 48.98 months. In Q1 of 2022, terms were 3.90% for 50.82 months.

Both factors have trended toward higher annual payments for the last three years. In 2023, the Index calculation was a low $260, but is now $374. The $114 increase is considerable (+44%), but keep in mind that levels remain historically low (Figure 3).

Figure 4. Farm Machinery Debt Service Index – Annual Payment to Service $1,000 of Debt (First Quarter Data, 2015-2024). Data Source: AEI.ag.

Higher rates vs short repayment periods

Another consideration is which has affected the Index the most: interest rates or repayment periods? Figure 5 breaks this down on an annual basis since 2015. As mentioned earlier, the Index increased $113 between 2022 and 2024. In total, 24% of the $113 increase was from higher interest rates, and 76% of the upturn was from shorter repayments.

Stepping back even further, variation in the Index – and annual farm loan payments – is often driven by repayment periods.



Figure 5. Source of Change in Annual Farm Machinery Debt Service Index (First Quarter Data, 2016-2024). Data Source: AEI.ag.

Interest expense index

Up to this point, the focus has been on annual payments. A combination of low interest rates and long repayment periods is necessary to get low yearly payments. However, stretching out the repayment period (Figure 2) also means more months of payment and interest accrued.

The final consideration is a companion index, the Farm Machinery Expense Index (Figure 6). While annual payments have remained historically low, the interest accrued over the life of those loans is approaching historic highs. At more than $130 in 2023 and 2024, the expense is 73% (+$58 per acre) than in 2021.


Figure 6. Farm Machinery Interest Expense Index, 1977-2024. Data Source: AE.ag.

Wrapping It up

Rising interest rates are occurring with historically long repayment periods. This means that the interest accrued over the life of farm machinery loans has significantly jumped and is historically high. This isn’t necessarily obvious as farm loan payments have increased slowly – and remain historically low. Furthermore, most changes to the Machinery Payment Index have come from changes in loan maturity, not changes in interest rates.

The implications of the repayment and interest expense underpin the importance of producers and ag lenders carefully considering the long-run implications of farm loans. The most unusual element of today’s lending environment isn’t interest rates but long repayment periods.

In conclusion, loans often involve tradeoffs between cash flow and interest expense. Extended repayment periods make cash flow capital purchases easier and are more attractive when interest rates are historically low. With rising interest rates – and all the challenges of lower commodity prices and rising equipment costs – the temptation to keep a long repayment period will be strong. However, the associated expense is much higher.

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