Wednesday, February 6, 2013

Financing the farm

I wrote about a farm that I'm purchasing, and as this is a pretty large purchase, I'm carefully working through the options. 

Disclaimer:  I'm discussing my own thoughts on purchasing and financing real estate here.  You should consult with an attorney or accountant or both before you do anything.  These are solely my opinions and my personal plans, not in any way my giving you advice, legal or otherwise. 

Background:  I think that we will have inflation at a rate of at least 3% for the next 10 to 15 years.  It's a simple way to get rid of deficits -- inflation hurts people who save or loan money, and no one has to vote for a tax increase. 

Current interest rates are as low as I think I will see in my lifetime.  I'm seeing rates of 2.75% for a 10 year fixed, and around 3.5% for 30 year fixed mortgages.

Current inflation rates are around 3%, so any interest rate that approaches 3% is, basically, free money. 

Commercial loans are roughly double that rate, at 5.5%.  So in this case, if I can finance it through a home mortgage it's a much better deal. 

Most people don't know this, but you can shop your loan around.  You can do this via a mortgage broker, who has several lenders to choose from, or you can do it yourself by taking your loan around to various lenders.  Having multiple checks on your credit score isn't a downcheck if you explain that they are you seeking a better rate for this single loan. 

In my case, I was able to get a rate quote 3.35% APR by approaching a couple of local banks, and offering a bigger-than-normal downpayment.   I chose a 30 year loan because you can always pay it
back more quickly, but it's nice to have the option of a lower payment if you need it.

So the projected mortgage payment for this property, including taxes, is about $1250 a month, which is about what you'd pay in rent for a house on a few acres around here.   I want to keep that number as low as possible because fixed costs are dangerous to a farm.  the bigger your fixed costs the less you are able to weather downturns. 

The issue that comes up though is that banks don't like to loan money on land; to make this fly I may have to finance the land portion as a commercial loan from a farm-oriented lender, at 5.75%, and the house/barns from a mortgage lender. 

Worst case is that I have to finance the whole thing as a commercial loan, and then do a lot line adjustment to put the house on its own separate lot so that it conforms to what mortgage lenders want, and then refinance the house. 

Which seems to be a lot of trouble and transactions fees, but given the difference in rates (5.75% vs 3.3%, $1,259 vs $1618 ) I'm cutting the interest rate nearly in half, and at $350 a month difference
the changes will probably break even in a year or two; and the intention is to keep the property for the foreseeable future. 

When I get to that point I'll do the math, and if it makes sense, I'll follow through on the least-cost option at the time. 

I wondered why a lot of these farms had their house on a small part of the acreage, and now I understand why; it's to make the mortgaging of the house simpler and easier.  Residential land is also taxed at a higher rate than agricultural land, and minimizing the amount of land that is "residential" also reduces your overall tax burden. 

To give you a feel for that -- taxes on 30 acres of cropland is around $200 a year.  Taxes on my townhouse on 1/8th acre is $2300 a year.  Big difference. 

What I did to allow me to chase these different rates and get the best deal was negotiate a long close time -- in this case 90 days.   If you pick too short a close time you severely limit your ability to find a better lender.  In this case I called the lenders I was interested in, got their typical lead time for the longest closes, and then added 30 days to that.  Some sellers will balk at a long close time, and the bank did, but I provided a letter from the slow lending institution, that the delay was on the loan origination side, and they finally agreed. 

You can always close faster than your close time, but having the extra time makes life simpler, which is how I prefer it.  I have enough time to pursue a mortgage loan, and if that doesn't go through, go for a commercial loan before we reach the closing date. 

1 comment:

becky3086 said...

Wow, things are so much cheaper here, lol. I don't know anyone who rents a house for $1000 here. Most run around half that.