With the Bank of Canada making its first interest rate cut in over four months earlier this month, now is the time for farmers to review their financing options, says Farm Credit Canada.
The central bank on June 5 reduced its key overnight lending rate by 25 basis points to 4.75%, with FCC projecting another two reductions this year to take the rate down to 4.25%.
The overnight target rate is used to set financial institutions’ prime rate and influences variable mortgage rates. When the overnight rate changes, the prime rate typically changes by the same amount.
A recent analysis by FCC assesses the costs and benefits of taking out a fixed or variable-rate loan, considering today’s economic environment and different forward-looking scenarios. The analysis shows that if the Bank of Canada were to drastically cut rates, borrowers could benefit from lower payments over a five-year period if they opt for a variable rate loan.
But if the Bank of Canada instead opts for a gradual approach in cutting interest rates, there would be little difference between taking out a fixed-rate or variable rate loan with respect to total payments over a five-year period. Yet, a fixed rate option would bring predictability in managing future interest expenses.
“Borrowers should think carefully about their personal risk level given the pros and cons between fixed and variable rates,” said FCC Manager of Economics, Krishen Rangasamy.
“An option that borrowers can consider is diversifying their debt portfolio by using a combination of fixed and variable rates. This allows them to benefit from both types and to spread their risk over different time periods. For example, a borrower could have a variable rate loan for a short-term project, and a fixed rate mortgage for a long-term investment.”
However, diversifying also adds complexity to managing multiple loans or mortgages, and may require more attention and monitoring. Therefore, borrowers should consult with their financial advisors and lenders to find the best solution for their specific situation and goals.
Rangasamy said that the interest rate cut is a good opportunity for farmers, agribusiness operators and food processors to take advantage of the lower borrowing costs, but he also cautions them to be prudent, and to have a contingency plan in case of unexpected events or changes in the market.
