Long Repayment Terms Keeps Debt Payments Low
Higher interest rates clearly make debt more expensive, but it’s not a direct connection to how those rates translate into annual cash flow obligations. Like the math behind every used car salesperson’s inquiry about the monthly payment, other factors, chiefly the repayment period, are also in play. Given the significant shift in interest rates, this Weekly Insights is an update and review of the Farm Machinery Debt Service Index, which we created to provide an idea of the annual obligation to service $1,000 of farm machinery debt.
Farm Machinery Debt Index
Using interest rates and debt maturity data reported by the Kansas City Federal Reserve, Figure 1 plots the annual obligation, or payment, required to service $1,000 of farm machinery debt. The data series, which began in the late 1970s, captures the significant burden that servicing debt required during the 1980s farm financial crisis. For farm machinery and equipment, interest rates hit a high of 17.9% (1981), and loan repayment terms reached a low of 8.4 months (1982). Short repayment terms and high interest rates made the annual obligations very high. During this era, the Index exceeded $1,000 between 1980 and 1985 .
By the early 1990s, the Index fell to a new normal of around $600. At the extremes, the Index fell to $387 in 1994 and was as high as $828 in 2006. During the 2006 upturn, interest rates were 8.4% over an average of 15.9 months. For comparisons, average terms in the first quarter of 2023 were 7.2% and 49 months.
After the Great Recession, the combination of low interest rates and long repayment periods pushed the Index lower. Prior to 2010, the Index only once slipped below $400 (1994); however, since 2010, the Index has been above $400 only twice, in 2010 and 2012.
In 2020, the Index hit a low of $287 with 4.8% interest rates over 46.7 months of repayment.
Most recently, the Index has remained historically low despite higher interest rates. For 2022, the average interest rate was 5.4% over 44.0 months. In the first quarter of 2023, interest rates were 7.2% and 49.0 months. Even with the higher rates, the Index in early 2023 was $292.
Stepping back a bit, the recent hike in interest rates has been fairly abrupt and could be blurred in the annual data. To that point, the average interest rate on farm machinery loans during the first quarter of 2022 was 3.90% but jumped to 7.23% during the first quarter of 2023. For a more granular look at the data, Figure 2 shows the Index values on a quarterly basis since 2010.
Again, we see that the Index has trended higher but overall remains historically low. So while interest rates are the highest since 2023, payments remain among the lowest.
Repayment Period Stretched
Figure 3, which plots the average maturity of farm machinery and equipment loans since 1977, unpacks the easily overlooked upward trend. Prior to 1990, loans were frequently less than 24 months. During the 1990s, the average repayment period was nearly 27 months. Since 2010, terms have averaged nearly 39 months. With the quarterly data (not shown), terms since 2020 have been stretched all the way to 45 months. And on four occasions, the quarterly average exceeded 50 months.
While interest rates capture all the attention, longer repayment terms have also reduced the annual burden of servicing debt. For those curious about which has affected the Index more- interest rate versus repayment terms – you can learn more from this 2022 AEI Premium article.
Wrapping It Up
The Farm Machinery Debt Service Index is a way of measuring the annual burden associated with financing a new piece of machinery. While higher interest rates will result in more interest expense, the Index highlights that the annual burden for serving $1,000 of debt hasn’t significantly changed in recent months. In other words, the farm debt that producers took on in early 2023 had a similar annual payment compared to the loans in late 2021 and early 2022. Of course, the trade-off here is longer repayment periods, which we’ll unpack in a future AEI Premium post.
For those still curious, be sure to take advantage of the risk-free trial to AEI Premium to read even more insights, such as these articles (here and here), on the other implications of higher interest rates.
 In extreme cases – such as the 1980s – producers would have paid off the $1,000 in less than a year. However, this Index assumes they serviced $1,000 worth of machinery debt for the entire year.