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September 16, 2020

The Drawbacks to 100% Farm Loan Financing

Are zero money down land loans a strength for American agriculture, or a weakness?

Zero down financing is a loan product that involves the financier to fund the full amount of the desired purchase without an initial down payment from the borrower. Although an attractive option for borrowers with limited cash flow when embarking on a new land investment endeavor, strings are frequently tucked into the fine print of these types of products and are a rarity among land loans. In fact, land and residential financing are commonly viewed the same yet carry distinct differences.

Similar to auto financing, residential financing is considered to be transactional. If the borrower does not meet payments, the lender repossesses assets in order to save their return. Comparatively, rural land ownership is more relational. A good land lender views a potential borrower not as a one-time transaction, but as a lasting partnership where each side leans on the other to cultivate a successful future. While exceptions do exist, zero down financing commonly creates an unbalanced relationship between stakeholders that the borrower ends up paying extra for in the end.

Why Some Borrowers Choose 100% Financing

If 100% financing comes with a higher price, why do people choose this option when securing a land loan? Several situational circumstances can lead a borrow to choose a zero-down loan, including:

  • Minimal savings;
  • Significant loan obligations;
  • Need for immediate liquidity;
  • Leverageable land equity; or
  • Desire to save capital for other investments.

Borrowers with minimal savings or restrictive cash flow often find themselves exchanging higher interest rates and stricter terms for increased access to capital. To secure a potential borrower’s position as a key stakeholder, land loan down payments typically range between 15 to 50 percent down depending on the discretion of the lender and means of the borrower. When it comes to a land loan partnership, a lender has more flexibility available to meet the borrower’s needs and ensure their future success without becoming overleveraged with debt if there is an alternative form of collateral contributed. An alternative for borrowers with constricted liquid capital is to use existing land equity as a down payment, to conserve capital for future operational expenses following the land purchase, and increase the flexible term options available to them.

Drawbacks to 100% Financing for Land

While the initial cash flow is a perk of a zero down payment loan, a 100 percent financing product comes with its own set of limitations.

Lack of Flexibility

A lack of collateral translates to a higher loan-to-value ratio (LTV), restricting the flexibility available to the lender to work with the borrower and provide payment support if they experience a difficult year. The more flexibility a borrower has, the more opportunity a lender has to capitalize payments in a deferment scenario in order to help the borrower maintain compliance if challenges should arise.

Higher Payments

Risk premiums are often required to offset the risk in a high LTV situation. Zero down financing lenders may also require a shorter amortization period to de-lever the debt down to a more comfortable LTV faster, further increasing the minimum payment required for the borrower. The less skin the borrower has in the game, the more weight a lender is obligated to carry. Higher risk for the lender translates to higher payments and rates for the borrower.

Risk of Overleveraged Debt

The worst-case scenario for zero down financing is the potential to overburden your operation with more debt than it can support. Setting up a loan structure that restricts cash flow and increases the chances of a borrower defaulting on a loan is a form of unethical lending that reputable lenders work hard to avoid. Exercise caution with a lender who is quick to secure zero down financing with minimal requirements as they are not doing their due diligence to protect the financial health of their clients.

Stay Financially Secure with AgAmerica

With a singular focus on agricultural land lending, AgAmerica goes beyond the limitations of traditional lenders to develop trailblazing solutions that bring lasting success to the farmers, ranchers, and landowners we are proud to serve. As a transparent and ethical financial land lender, our company values big-picture thinking over quick-fix solutions. Our mission to support American farmers means equipping them with the resources needed for lasting success—because, in the end, their success is our success.

Sometimes, supporting a beginning farmer means directing them to federally-backed loan programs that give them a safe, minimal to no down payment loan to get their operation up and running. We maintain long-term relationships with many of these farmers and offer honest financial counsel so that when the time comes to grow their operation, we are able to provide the flexible financing required to get the job done.

When searching for land loan financing, look for a partner not just a bank. If you would like to learn more about the financing options available to you through a partnership with AgAmerica, please contact our lending experts today.

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