Avoid the Equipment Debt Trap: Smart Strategies for Farmers

Typical equipment loans have terms that range from four to eight years with equal combined principal and interest payments. Leases are similar but often have shorter terms and take the equipment's value at the end of the term into account. The problem with these loans is that they often have short terms and large payments, which can create financial strain. Lenders want to make sure farmers have equity in the equipment to protect against default, but this can make the payments higher than necessary. Farmers often don’t account for unexpected events, like droughts or crop failures when signing these agreements, leading to cash flow problems when these events inevitably occur.   

With lease terms increasing up to five years and equipment loans of up to eight years, there is a higher risk than ever that a bad year will happen during the loan period. When cash flow gets tight, the fixed payments stay the same, and cash can quickly run out. Farmers often don’t realize that even low-debt operations can go bankrupt if they miss their payments. They assume they’ll be able to borrow against their farm’s equity if problems come up, but that isn’t always possible. The one time you need an equity takeout and can’t get one, may turn into a pivotal moment in your farming career.   

One strategy is to use a mortgage debt instead of equipment loans to help lower your yearly debt payments. This works because mortgage loans usually have much smaller principal payments. As long as you keep a sizable cushion, this can help you avoid missing payments if crop problems or low market prices impact your income. If you have extra cash, most mortgages allow you to make extra payments without a penalty. This can help you save money on interest when using this strategy.    

Another risk management strategy is to stagger your equipment payments so that some loans or leases mature each year. This way, payments can be reduced by keeping older equipment for an extra year or two until things improve. If refinancing is needed, paying out some of the equipment loans that are close to maturity with longer term debt will reduce your annual payments significantly making it easier to qualify. If all of your loans and leases end at the same time, refinancing early in the loan term will be much harder, and the buyout amount could be too high for the bank to approve the refinancing.  

A third strategy would be to keep your loan terms shorter and always have some equipment already paid off. Instead of borrowing money over 8 years, have some equipment financed over just 4 or 5 years with other equipment paid off. This way, your total payments stay about the same, but you’ll have more flexibility when it comes to refinancing if you need to at a later date. The truth is, if you can’t afford the payments over 4 or 5 years, you probably can’t really afford that equipment at all. 

At Glengarry, we specialize in helping farmers restructure loans to get through tough financial times, and we are experts in consolidating and refinancing equipment debt for minimal cash flow impact.  If you your equipment debt isn’t as smooth as you’d like it to be, start a conversation at JGinquiry@glengarry.ca today to learn more about how we can improve your cash flow.