Refinancing a loan can be a strategic financial move, offering borrowers the opportunity to lower their interest rate, reduce monthly payments or adjust loan terms to better suit their financial goals. Refinancing involves replacing an existing loan with a new one, ideally under more favorable terms. This process can lead to significant savings over time, but it also comes with considerations such as fees, credit requirements and potential long-term costs.
Let's explore key factors to consider before deciding to refinance your land loan.
Refinancing Strategies
Whether your goal is to reduce your monthly payments or pay off your land loan early, there are several strategies you can use to take advantage of lower interest rates.
Refinancing is the replacement of an existing loan obligation with another loan obligation under different terms.
Re-amortization means changing the number of years to repay your loan.
Repricing is simply changing the interest rate with your existing lender.
When considering your refinancing options, compare the new loan terms – including the rate and number of years to repay the loan – to your existing loan terms. Depending on your situation, it may be beneficial to modify the rate and length of the loan term at the same time.
It’s also a good idea to compare loan terms alongside the cash flow expected from your income to help you better manage payments. Consider the following refinancing scenarios.
Comparing Rates and Term Length
Here is an example of refinancing to a lower interest rate.
| Type | Original Loan | Refinanced Loan |
|---|---|---|
| Loan Amount | $500,000 | $500,000 |
| (Remaining) Term | 10 Years | 10 Years |
| Interest Rate | 8.25% | 7.25% |
| Annual Payments | $75,745 | $72,347 |
By refinancing your land loan to a lower interest rate, you could reduce your annual payment by $3,398.
However, if you want to improve cash flow demand with an even lower payment, you can stretch this loan over 15 or 20 years. Note that the longer you extend the number of years to repay the loan, the higher the rate you will potentially pay.
| Loan Amount | Term | Interest Rate | Annual Payments |
|---|---|---|---|
| $500,000 | 15 Years | 7.5% | $57,010 |
| $500,000 | 20 Years | 7.75% | $50,388 |
As you can see, the number of years to repay a loan has more impact on your cash flow than the rate of your loan. A 10-year loan at 8.25% has a payment of $75,745 versus a 10-year loan at 7.25% has a payment of $72,347, but a 20-year loan at 7.75% reduces the payment to $50,388.
Our article on payment structures can also help you understand how different payment and term scenarios would impact your total cost to own and your cash flow.
Cash Rent Equivalent
Another important consideration includes comparing the annual expenses of the land to the expected annual income of the ground on a per acre basis. The expression of the annual expenses (loan payments and real estate taxes) is called the cash rent equivalent (CRE).
Using the same example above, let’s look at the cash flow impact of different loan maturities.
The $500,000 originally financed 160 acres. The property taxes on this farm are $3,500 per year. The calculation for determining CRE is:
- principal + interest + taxes, divided by the number of tillable acres.
The CRE on the original loan amount of $500,000 over 10 years with an 8.25% interest rate is $75,745 (principal and interest) + $3,500 (property taxes) divided by 160 (number of acres) = $495/acre.
The CRE calculations for the original loan and earlier examples are outlined in the table below:
| Loan Amount | Term | Interest Rate | Annual Payments | Annual Taxes | Cash Rent Equivalent |
|---|---|---|---|---|---|
| $500,000 | Original Loan | 8.25% | $75,745 | $3,500 | $495/acre |
| $500,000 | 5 yr IFR/20 yr | 7.25% | $48,491 | $3,500 | $325/acre |
| $500,000 | 20 yr FTM | 7.75% | $50,388 | $3,500 | $337/acre |
| $500,000 | 30 yr FTM | 8% | $44,880 | $3,500 | $302/acre |
Average annual per acre savings (range) = $158 - $193.
Remember to consider all sources of income when considering your cash flow needs.
Other Considerations
In addition to evaluating your refinancing strategies, comparing rates and term length, and calculating CRE, there are several questions you should be prepared to ask when refinancing a farmland loan, such as:
- What costs are involved in financing a new loan or refinancing an existing one? Abstracting, appraisal, title opinions, recording, others?
- Is there an origination fee in doing business with a particular lender? If so, how much? Does it vary depending on loan size?
- Is there a prepayment penalty if I want to pay off or pay down the loan early? If so, how is it calculated?
- How do lenders handle the following loan servicing examples and what are the costs associated with them?
- Access to re-borrow equity
- Partial release
- Substitution of collateral
- Assumption of the loan
- If rates go lower, is the lender willing to reduce the rate?
- Does the lender have the ability to finance additional loans using the same mortgage that is filed on your existing collateral? What is the cost if they do?
- Does your lender offer cash-back dividends that can reduce your cost of borrowing?
