Farming costs add up quickly. Between equipment, seed, fertilizer, livestock, and everything else, it seems like bills are always rolling in, making it hard to keep up. If you’re like most farmers and ranchers, you’ll likely need to borrow money at some point in your life to fund these expenses.
To know what your borrowing options are (and which one is best for your situation) it's important to understand how credit decisions are made. That way, you can estimate how much you might be approved for. Most lenders consider five main criteria when reviewing your loan application and determining the terms and conditions of a loan. Remembering these 5 c’s of credit can really come in handy when preparing to meet with your loan officer so you know what to expect.
Character—the borrower’s dependability and integrity
Character is important. Just as you wouldn’t want to lend money to someone you don’t know you can rely on, banks aren’t fond of loaning out funds to people they can’t trust. When a bank assesses your character, it isn’t about learning about who you are as a person as much as it is about learning who you are as a borrower. Basically, banks want to know whether you have a history of paying back what you’ve borrowed to see if they can expect the same.
If you’re concerned about your credit character, take a look at your credit score and see whether there are any problems you can address to make yourself a better candidate before meeting with your loan officer. Then, gather all of your financial records and business plans and organize them into a professional package to submit to the lender for review. Since the package will be their first impression of you, it’s best to make it neat and easy to navigate!
Capacity—the applicant’s financial capacity to repay the loan and meet all financial obligations
No matter how good your character is, you can’t pay back money that you don’t have. So, lenders will also gauge your capacity, or your ability to make your loan payments. To do this, they’ll consider your income, any other payments you have to make, and other factors like taxes and living expenses. Lenders like to see a minimum capacity ratio of 1.15:1. In other words, after living expenses and taxes are covered, you should have at least $1.15 of available cash flow for every $1 of debt to show that you’re able to pay your bills.
Since farming is a unique career that doesn’t always offer the same consistency that other paychecks do, lenders must take many factors into account. When evaluating your capacity, your income is calculated based on a conservative projection of revenues, including your crop sales, non-farm income, etc. To allow some flexibility for emergencies and adverse events, lenders like to see that your available funds are at least 1.25 times the amount of debt payments you have in the coming year.
Capital—the applicant’s liquidity and solvency
Your lender needs to know that you have enough equity in your assets to secure operating loans and take care of unexpected circumstances should they arise. In general, 50% owner equity is a good target, although the percentage will vary based on the nature of the loan. To determine your owner’s equity, divide your net worth (assets minus liabilities) by your total assets.
Collateral—the physical property that will minimize the lender’s risk in the event of loan default
The amount of collateral required for a loan will depend on the specifics of your loan request, but it will typically be the property you’re financing. Be prepared to discuss what you’re able to offer as collateral and provide as much detail and documentation as you can about its value and condition so the lender can estimate its value. Making sure you know the value of assets you own outright beforehand will help.
Conditions—the conditions for granting and repaying the loan
Agriculture is a volatile and often cyclical industry. Because of this, your lender must consider the conditions and outlook for your sector and assess how well your operation is prepared to weather whatever storms may come based on how you’ve performed in the past. For instance, if you’ve maintained a reasonable financial position during tough conditions in the past, it’s likely that you’ll be conservative when times are good, knowing that a downturn is possible.
Our loan officers will strive to set a loan repayment schedule that’s reasonable for you and your specific situation. The more information they have, the better they can understand your needs, which is why organizing your financial documents and communicating with your loan officers is essential!
The Bottom Line
If you consider the 5’c and how they apply to your farm operation and financial situation before meeting with your loan officer, you’ll be in a better position to get the credit you need. If you’d prefer not to meet in person, you can also submit your analysis in writing with the loan request.
If you have questions about credit or are looking to secure a loan, we’re happy to help! Contact us to get in touch with an experienced professional. We look forward to helping you accomplish your financial goals!