Whether you buy a new tractor or take out land or a home mortgage, long-term loans are important tools. They help you buy the expensive equipment that’s needed for work, and you pay them back over more than a year. Just make sure you stay current on the payments so you never fall behind.
Just like a car, most big purchases come with a loan attached. That means instead of paying just principal, you’re also on hook for interest, which can add up over the long term. The rate, balance and term determine the cost of the loan. Make sure you figure lifetime cost of the debt in your plans, not just monthly payment.
Interest and time add up, and that’s how much it’s really going to cost you.
Amortization Schedule
Figuring out how much of each payment is principal and how much is interest can sometimes feel like learning a new language. But an amortization schedule is really just a set of regular payments that are worked out for you. They list your starting balance, payment, interest, principal and remaining balance. Start out with your principal, rate and term, and the total gets figured automatically.
The Equal Payment, or Fixed Payment, option is the most common payment schedule. This is typically the type of payment that your lender quotes you when asking for a loan payment. This payment is determined by the Amount Financed, the Interest Rate, the Term and the number of payments per year.
The number n represents the total number of years that the loan will be for and m represents the total number of payments per year.
Make sure that your rate i is entered as a decimal, not as a percent (so if your rate is 3%, enter it as 0.03). So if you’re making monthly payments, m is 12; if you are making yearly payments, m is 1.
Part of every payment goes to cover interest, then the rest goes to paying down your principal balance. Most farm loans are at a fixed rate, but adjustable rate loans are sometimes available. These start at a lower interest rate but the payment can change over the course of the loan. The rate starts lower because the risk is passed on to the borrower and if the rates move in the future, the payment will move as well. This guide sticks to fixed rates.
A bigger chunk of the payments in the beginning go toward interest. That’s because the interest amount is figured based on the starting balance for each payment. The more you owe, the more you pay out in interest. So in the first month or year of the loan, you’re starting with a much bigger balance and more of the money you hand over goes to interest than if you made the payment at the end of the loan.
The other part of each payment, after the interest, pays down the principal.
Principal = fixed payment − interest.
The amount of it goes up every time you make a payment because as the balance shrinks, the interest portion is less and less and the amount applied to principal gets bigger and bigger.
How much will it cost? Assuming a producer borrows $30,000 for five years at 5 percent and paying once a year, here’s how that schedule might look.
In the first year, the principal balance is the starting amount of the loan. After that, it’s last year’s ending balance.
In this case, the fixed payment is $6,929.24 for the loan amount for five years, and with annual payments there are five of them.
In the first year, the interest is .05 x $30,000 = $1,500.
The principal is $6,929.24 − $1,500 = $5,429.24.
By year five, since the balance is dropping every year, the interest is dropping and the principal is rising. For example, by year five the interest amount is $329.96. That means year five’s principal amount is $6,599.28.
As you can see, your balance (or what you owe the lender) is based on the initial amount financed minus the principal paid to this point.
You end up paying $34,646.22 for a $30,000 loan because the $4,646.22 in interest gets paid back to the bank in the end. How much you give away in interest depends on the loan amount, rate, length of the loan and how many payments you make every year.
If you take that same loan of $30,000 at 5 percent and now extend the term to 10 years, what happens?
By breaking the loan up into 10 years’ worth of payments, the producer pays out $38,851.37. That’s $4,205.15 more than the five-year loan. Notice how much less principal you pay at the beginning of the ten-year schedule than in the five-year schedule. The shorter the term of the loan the more the interest portion is reduced and the larger the principal portion. A shorter term costs less on the whole. A longer one may look more attractive because the monthly outlay is less, but the bigger balance means you’ll be paying out more in interest. If the longer loan gets you a better rate it could save money.
30-year, $100,000 Mortgage
Buying a home is a lot like taking out a tractor loan. It’s a big investment and you need to stay current on the payments. What’s different is how long home loans run and how much more involved they can get. To figure out how this works, here’s an example: If you borrowed $100,000 at 7 percent for 30 years, using the February 2023 average for Mississippi home mortgage rates, this is what it might look like.
For that mortgage, you’d pay $665.30 a month. 30 years is 360 payments.
This brings the total payments on that $100,000 mortgage to $239,508.90. The interest is higher than the principal, or the total borrowed. A 7 percent rate is high for a loan, and you can end up spending more in interest over a 30 year span then if you chose a shorter term.
Shave Dollars Off the Total
OK, you’ve crunched the total cost of the loan. Now what? Can you make the number smaller? Maybe. If you can get the interest rate a little lower, you can shave some dollars off the total. As always, this comes down to shopping for the right lender. Even a fraction of a percent can save you quite a bit over the long run. Many lenders’ rates are in the same ballpark, but a small difference can mean a big deal. Especially if you are in it for the long haul.
A shorter loan term can reduce total interest, but may increase each payment. By lopping several years off the end of a loan you’ll boost the principal amount of each payment and lower the interest. As the two $30,000 examples above demonstrate, not only do you pay less in interest by paying out the loan quicker, but also the interest amount drops each month as the principal drops.
When you take out a loan, the lender makes money off of it. With each payment you make they’re getting some of their investment back, plus a little interest on top. If you pay off the loan early you’re saving money on that interest. In some cases the lender may charge a penalty for cutting the loan short, so you’ll want to check on that before deciding to start writing extra checks. But if they don’t, getting it paid off early can save you money in the end. Accelerated, or early payoff, is really just paying the loan off sooner than the lender wants. After all, they lose out on the interest they are planning to get from you down the road. That’s where the prepayment penalty comes in, to even out the risk for the lender.
The bigger the down payment you put down on a loan the less you’ll owe for it. The principal determines the interest, which is the price of the loan. You can knock dollars off of the lifetime cost of a loan by putting down more on the front end of it.
Of course, there’s a lot that goes into running a farm or business. From field help to fuel, so many of the costs keep creeping in. Some of those are going to have to come from a loan, but remember that borrowing money costs money, too. Before you start writing out applications, be sure you consider a few things.
Before you borrow any money you need to decide how those payments are going to affect your day-to-day cash flow. Can you make them without batting an eyelash? Do you have enough cash built up now to make it through the term of the loan? If you can’t answer both those questions, think long and hard before signing on the dotted line.
The floating rate mentioned earlier is the one alternative to borrowing at a fixed rate, and it may or may not be worth considering. Lenders’ floating rates may be slightly lower than their fixed rates, but those payments can go up during the term of the loan. This is why it’s smart to ask both rates at the same time when shopping for a loan. You’ll want to compare them before you sign, and keep in mind that the floating rate could rise over the loan.
About Delancey Street
Delancey Street is a business debt settlement company that helps business owners nationwide. Our goal is simple: negotiate proposed settlement terms with creditors, subject to their agreement. We are based in New York. We tell you how it is; because your business and future is on the line.
