Interest Only Loans: Thoughts & Perspectives

You can see the telltale signs that we are near the end of asset-based lending cycles with financial offers being made by lenders who are aggressive in the marketplace.

For example, a large majority of the real estate mortgages being made in California are being extended on interest only terms, 100% based on appraisal value. These terms are now creeping in the agri-lending marketplace, which is reminiscent of the early 1980s in the other real estate boom. What are the implications?

Interest only loans on real estate, livestock and in some cases machinery are usually a last resort for one with pinched cash flows and earnings, but a strong balance sheet.

If this balance sheet value continues to increase because of capital appreciation then the farmer, rancher and the household can benefit through inflation if they decide to sell.

The big downside, however, is when the real estate and other asset values head south in value. The questions to ask will be, “Will the lender stand by you in these adverse times? Will the cash flows and earnings improve in the tough times?” The most obvious answer is “not likely.” Will you have financial liquid assets that can be used as a stopgap in the sharp or extended down period?

Before signing on the bottom line on some of these offerings, please think through the downside, because in the 1980s we were down this same road.

Side note
Thirty-six percent of mortgage loans on homes are variable rate. A 1% increase can represent a $276 reduction in monthly family household buying power. Do you still want an interest only variable rate loan?

My e-mail address is:sullylab@vt.edu

Editors' note: Dave Kohl, The Corn and Soybean Digest Trends Editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups.

To see Dave Kohl's previous road warrior adventures type Dave Kohl in the Search blank at the top of the page.

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