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How Much Land Can I Afford?

Purchasing a piece of ground is no small decision. When you compare current farmland values with crop prices and average annual farm income, buying additional acres can seem daunting. Here are three questions to answer when deciding how much land you can afford.

What Will My Payment Be?

At the most basic level, it is important for potential buyers to know how much they’ll be paying for the land they want to purchase. There are a number of tools (like our Loan Payment Calculator) you can use to calculate the real estate loan payments based on the principal amount, interest rate, and term of the loan. Factor in your local real estate tax rates and you’ll have a realistic idea of the cost of owning the land. Click for more details on loan payments, including even and decreasing payments.loan payment calculator

How Will I Afford the Payment?

Now that you have a reasonable estimate of your costs, it’s time to decide if you can afford the payments from a cash flow perspective. Yes, you will have access to additional revenue-generating acres, but when you factor in your input costs, overhead, and debt servicing, you may need to find additional ways to subsidize your payment. Whether that means cutting expenses in other areas, providing custom farming services, or generating additional off-farm income, it’s important to have options when making a financial decision of this magnitude.

Running some scenarios using our affordability calculator is a good way to analyze if you can service the debt associated with a land purchase. Different combinations of loan terms, commodity types, yields, prices and down payments will help you determine the feasibility of a purchase.affordability calculator

How Will This Affect My Farm’s Overall Financial Picture?

Understanding your current financial position is critical to the success of a land purchase. Take the time to review your balance sheet, cash flow and income statements to determine how much debt you can reasonably take on. You are in a good position to buy if you can both service the debt and remain profitable. At least on paper.

Just because you can afford something doesn’t necessarily mean you should buy it. Land purchases have a major affect on your operation’s working capital and, if financial circumstances changed, could potentially limit your ability to get your farm out of a tough spot. You should consider the opportunity cost – the things you are giving up in order to make the purchase – to decide if the long-term benefits outweigh the short-term sacrifices.

Key Factors of a Payment

The amount of your payment is determined by four primary factors:

• Amount borrowed
• Interest rate
• Term of the loan (number of years)
• Frequency of payment

For example, if you borrow $100,000 at a 5% interest rate over 20 years on an annual payment schedule, your payment will be approximately $8,100 per year. Keep these numbers in mind as you continue to read.


Even Payments

Each time you make a loan payment, a portion of the payment goes toward the principal (the amount of money you borrowed) and the interest (the amount owed to the lender for using their money). If our borrower elects to have an even (or level) payment, he/she will pay $8,100 each year for 20 years.

On an even payment schedule, a larger portion of your payment goes toward interest at the beginning of the loan term, as you can see in the sample amortization schedule below.

# Payment Interest Principal Balance
1 $8,102.11 $5,4444.44 $2,657.67 $97,342.33
2 $8,102.11 $4,934.72 $3,167.39 $94,174.94
3 $8,102.11 $4,774.15 $3,327.96 $90,846.98
4 $8,102.11 $4,605.44 $3,496.67 $87,350.31

 

 

As your loan reaches maturity, these amounts flip and more of your payment is allocated to paying down principal.

# Payment Interest Principal Balance
17 $8,102.11 $1,457.88 $6,644.23 $22,035.32
18 $8,102.11 $1,117.07 $6,985.04 $15,050.28
19 $8,102.11 $762.97 $7,339.14 $7,711.14
20 $8,102.11 $390.97 $7,711.14 $0.00

 

With this structure, the cost of ownership (the amount you pay to borrow $100,000) comes out to be approximately $162,020.


Decreasing Payments

Did you know you might also have the option to use a decreasing payment schedule? Under this structure, the borrower pays down a set amount of their principal each year while the interest payments shrink over the life of the loan. This structure requires higher payments up front, but significantly smaller payments toward the end of the loan.

As detailed below, you can see that the principal payment is $5,000 throughout the life of the loan, while the interest payment continuously gets smaller.

# Payment Interest Principal Balance
1 $10,4444.44 $5,444.44 $5,000.00 $95,000.00
2 $9,815.97 $4,815.97 $5,000.00 $90,000.00
3 $9,562.50 $4,562.50 $5,000.00 $85,000.00
4 $9,309.03 $4,309.03 $5,000.00 $80,000.00

 

 

# Payment Interest Principal Balance
17 $6,016.67 $1,016.67 $5,000.00 $15,000.00
18 $5,760.42 $760.42 $5,000.00 $10,000.00
19 $5,506.94 $506.94 $5,000.00 $5,000.00
20 $5,253.47 $253.47 $5,000.00 $0.00

 

This structure reduces the cost of ownership because you pay down the principal on your loan more quickly, reducing total interest paid over the life of the loan. Based on our original example, the cost of ownership using a decreasing payment schedule is around $153,615 – a savings of more than $8,400 over even payments.


Other Considerations

The interest owed to your lender is based on the loan’s outstanding principal. The quicker you pay down your principal, the less interest you owe. Therefore, you can reduce the amount of interest owed by increasing the frequency of your payments.

In the charts, you can see how increasing your payment frequency can reduce the cost of ownership for both even and decreasing payments. If your operation can handle more regular payments, it may be a good option to reduce the overall loan cost.

Payment Schedule (Even) Cost of Ownership Savings
Annually $162,020.00 --
Semi-Annually $160,870.00 $1,150.00
Quarterly $160,300.00 $1,720.00
Monthly $159,915.00 $2,105.00

 

Payment Schedule (Decreasing) Cost of Ownership Savings
Annually $153,615.00 --
Semi-Annually $152,350.00 $1,265.00
Quarterly $151,715.00 $1,900.00
Monthly $151,290.00 $2,325.00

 

 

The term of your loan also influences the cost of ownership. A 22-year term loan is common for agriculture real estate, but you may have the option to increase or decrease the life of the loan. In the chart, you can see how much the loan term affects the cost of ownership.

 

Term Cost of Ownership Savings
30-year $197,440.00 --
25-year $179,280.00 $18,160.00
20-year $162,020.00 $35,420.00
15-year $145,715.00 $51,725.00

 

Longer loans typically make sense when cash flow is a concern. Your regular payments will be smaller, but you end up paying more interest. If your operation can handle larger payments, decreasing the loan term will save you money on interest and can often help you lock in a lower interest rate.

Summary

Purchasing farmland is an important, emotional decision. The key to making it work is staying grounded in the numbers and knowing what you can realistically afford based on your business. Work with your lender to find the loan terms that work for your operation and consider the ways you can subsidize any difference between the additional income and your payments.

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FCSAmerica serves farmers, ranchers, agribusinesses and rural residents in Iowa, Nebraska, South Dakota and Wyoming. For inquiries outside this geography, use the Farm Credit Association Locator  to contact your local office.