What is an Ag Operating Line of Credit and how does it work?
With the second highest number of farms in the United States, farming in Missouri is a $93.7 billion industry. Despite these big numbers, the profit margin for running a farm operation, especially during times of record-high inflation with input costs up 10-20% over last year, can be slim. Even during the best years, the seasonal nature of farm operations means there are times of year when cash reserves are always low.
One financial tool available to farmers during those lean times of year has traditionally been a farm operating line of credit (LOC). In this post, we’ll describe the ins and outs of utilizing lines of credit for your Missouri farm, from what to expect from an LOC (compared to other forms of credit) and when to use them, to how they can help you improve your agricultural business—whether you run a hog farm, focus on corn and soy production, or a smaller, diversified ag business. Let’s start with the basics.
What exactly is an Ag Operating Line of Credit (LOC)?
Unlike a business term loan, where you receive a lump sum of money which is paid off in regular, set installments, a LOC is a revolving credit line, functioning more like a credit card than a standard loan (in fact, many modern lines of credit let you utilize a debit card to pay for things!). When you have a revolving credit line, there is a maximum dollar amount that you are allowed to use, but you don’t need to use that full amount all at once—or ever, even. Instead, you use it to pay for things as needed, then make monthly payments on the balance. But as with loans, lines of credit and credit cards have some key distinctions that can make a difference when choosing the right one for your specific ag business purchases. Let’s dive into the details to learn more.
Line of Credit vs. Credit Card
Like a credit card, you only pay for interest on the amount of money you borrow, and you aren’t required to pay the full balance off each month. And like a credit card, there is a maximum amount you can borrow. Once you spend the whole LOC amount, you can’t use it anymore until you begin paying it off.
There are also some major differences between a line of credit and a typical credit card. Firstly, the amount you are able to access tends to be much higher with a line of credit. While business credit card spending limits can be around $5,000 on the low end to around $50,000 on the very high end, it’s not uncommon for business lines of credit to be $100,000 or more, depending on the business’s credit history, income, and assets.
Additionally, most Ag business lines of credit don’t last forever—they are subject to occasional reviews (often annually) to ensure that the terms still work for all parties involved, and no major changes have happened in the interim. Credit card accounts, on the other hand, are often considered indefinite, as long as you keep making your payments.
Lastly, the interest rates on lines of credit tend to be less than those of credit cards—particularly if your LOC is secured.
Secured vs. Unsecured Ag Operating Lines of Credit
When a loan or debt is ‘secured’, that means that some asset is tied to the loan. There will be a ‘lien’ on the asset, meaning that should you fail to make payments, the lender has the legal right to acquire it to compensate itself for the loan value. What this means for lenders is that they have confidence that even if you don’t make payments, they won’t lose out on the total value of the loan. What this means for you is that, because lenders are more confident in the loan, with a secured line of credit the interest rate will be lower.
So how do you ‘secure’ an ag operating loan or line of credit? Real estate is the most common kind of collateral used for these loans. However, if you don’t want to have a lien on your farm property or risk losing it, should the worst case scenario happen and you fail to make payments, you can also use other property of value, including farm equipment, to secure a line of credit.
Keep in mind, it is possible to get an unsecured line of credit, especially if you can prove a record of significant income and have a good credit history—but you can usually expect your interest rate to be somewhat higher in this case.
Line of Credit vs. Term Loan
As we mentioned above, LOCs are structured quite differently from typical business loans in terms of how the funds are received and how they are paid off. The major thing that sets them apart is that, with a term loan, you will receive the balance of the loan all at once. But what are the other major differences?
With term loans, interest rates and payments are fixed for the life of the loan. Once you are approved for the loan, you will know exactly what your monthly payment will be, how much interest in total you will pay over the life of the loan, and how many months you will have to pay it. You pay interest on the full amount of the loan from the time you receive the funds too. Of course, if you are able to pay the loan off earlier, this can decrease the ultimate amount of interest paid and time it takes to repay the loan. However, as long as you make your payments on time, neither the interest or term length will ever increase. This sort of lending product is exceptionally stable and easy to manage from an accounting perspective.
With lines of credit, both interest rates and your monthly payment amounts can change. To begin, you only pay interest on the amount you actually borrow—you don’t have to pay any interest (or make a payment at all) if you haven’t used any of the balance available to you. Once you start using the line of credit, your payment will be calculated based on the current interest rate and how much you owe.
Depending on the terms of your line of credit, your interest rate may be ‘variable’, meaning it will change over time based on the current market rate and the rate your lender sets. In other words, your interest rate could go up, or it could go down, which will affect your monthly payment sizes.
Just as with term loans, your interest rate can vary based on your credit history, current market rates, and whether or not it is secured. If the deciding factor for you is interest, speak to your lender to see which loan product would work more in your favor.
What do I need to apply? Do you need a good credit score for an Ag LOC?
As with any major loan, there are certain things you need to do to qualify so that your lender can be sure that you are not only able to make payments based on your available capital, but also will reliably do so. Getting the following items in order is a good starting point as you prepare for your application:
- Bank statements for your farm business (and possibly your own personal statements)
- Tax returns that detail income and expenditures
- Information about other debts: loans, credit cards, and lines of credit
- Documents for any property you intend to use as collateral
Having a record of credit is also essential to qualify, and the higher your credit score, the better your chance of qualifying and getting the best interest rate. If you have questions about your credit or how it will impact your ability to get an LOC, you can always reach out to your lender before submitting the application.
What should I use an LOC for?
Ag business lines of credit can technically be used for anything related to your farm business, from smaller day-to-day purchases to larger expenditures.
For instance, for those smaller purchases that you can pay off each month, using a credit card might work the best. This allows you to build credit, organize your spending for tax purposes, and maybe even earn some rewards in the process.
For larger purchases, such as real estate or pricey farm equipment, you may find a better rate by getting a specific loan for that purchase, where the item directly secures the loan. For instance, you might choose to get a mortgage or land loan for a new piece of property, or an equipment loan for a new combine.
The most popular use of LOCs for farmers is for the regular operating expenses as a means to help manage cash flow. Use an LOC when your cash flow is low and you have daily operating expenses to pay. Whether purchasing soybean seed or paying for your hog farm’s routine inoculations, lines of credit are an excellent way to bridge the funding gap while avoiding significant new debts. Consider an ag line of credit for:
- Seed purchases
- Input purchases
- Livestock purchases
- Smaller equipment purchases
- Equipment repairs
- Facility and infrastructure repairs
- Labor costs
- Other major operating expenses: insurance, fuel, and veterinary expenses
Utilize Your LOC to Expand Your Enterprise and Increase its Efficiency
Oftentimes, we make financial decisions based on our current available funds, which can limit opportunities for growth. Beyond using your line of credit for larger operational expenses, consider how the extra funding can prove useful in expanding your business, increasing yields, and improving farm efficiency (and a bigger bottom line).
- Increasing inputs for increased yields
- Purchasing larger reserves of fuel when prices are low
- Improving irrigation systems for increased yields or water efficiency
- Hiring more labor to get the job done
- Upgrading grain storage and other facilities
- Completing energy-efficient improvements
- Improving ventilation systems
- Increasing the number of livestock head
BTC Bank Can Meet Your Lending Needs
Looking for ways to improve your farm’s cash flow and improve its operations? BTC Bank can help match your ag business with the right lending products to get started today. Our Farm Operating Lines of Credit, which can be used to cover a wide variety of ongoing farm expenses, can help fill the gaps in your budget and provide funds to keep your farm running. And we also offer a variety of other ag loans to meet your needs, from Livestock Loans & Cattle Financing to Farm Equipment Financing & Tractor Loans. Stop by a branch today to apply for a farm line of credit or learn more about all we have to offer.