# The Interest Rate Debate



## Barwelle (Feb 23, 2011)

Hey everyone, so as some of you may remember I have been saving up to purchase farm land. The time has come, some bare land (no buildings, etc) has come up that we (brother and I) are buying.

We are struggling with choosing how long of a term we should go with. The loan will be for 20 years. There is no variable rate. What we are considering is a 5-year term at 4%, 10-year term at 5%, and 20-year term at 5.5%. There are lower rates available elsewhere, but this organization offers a 1.5% discount for beginning farmers for the first 5 years on the above rates, so they are the best deal in town for the next 5 years.

There are no pre-payment penalties. We have the means to make extra payments, and intend to do so, but presumably we will be buying more land in the future so can count on having debt for the whole 20 years and beyond.

Deciding on a rate is what we are having trouble with. It would be nice to know what our payments would be for the whole duration of the loan, but of course that comes at a premium. Something I am considering is to lock in half for 10 or 20 years, and half for 5 years (this is allowed). Then any extra payments we make will go to whichever is the highest rate at the time.

So I'm looking for any input my fellow CMF'ers might have, primarily about which term length to go with. I thought I had no idea what to do, but as I type this, I realize I am leaning towards splitting it between 5-year and 10 or 20-year terms, to make a compromise between the risk of a 5-year term and the stability of longer terms. Still open to any comments though, I am sure there are some aspects I have not thought about.


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## andrewf (Mar 1, 2010)

Are you going to be renting the land? Does the land currently yield >5.5%? I would be tempted to go with the 20 year term. If for whatever reason rates actually fall, you have no penalty for refinancing.


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## none (Jan 15, 2013)

I thought that by law you could only have 5 year terms (ten year terms are a bit of a scam by the banks). Are we actually talking amortization here?


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## Barwelle (Feb 23, 2011)

We won't rent it out, we'll be farming it ourselves.



andrewf said:


> Does the land currently yield >5.5%?


Before interest and principal payments, it will yield about 6%. Once you include loan payments, it will actually be cash flow negative... however, our net worth will increase by about 1%/year to start, increasing as the interest payment goes down, and not accounting for any land appreciation.

It's pretty tight but it is what it is. We have more than enough off-farm income to make up the shortfall. Farming is an expensive business to get into.


none, I'm not sure where you got that idea... numerous banks and other lenders offer 7 and 10 year terms, and these guys do have a 20-year term. They are a specialty lender though, not a bank, not sure if you could get a 20-year house mortgage anywhere!

By law, mortgages are currently limited to 25 years, maybe that's what you are referring to. (There used to be 30, 35, and I think even 40 year mortgages allowed)

I would say that ten or twenty year terms are not scams... it's just a trade-off... you pay more in interest so that you have less interest rate risk.


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## andrewf (Mar 1, 2010)

This is, I'm assuming, Farm Credit?


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## none (Jan 15, 2013)

No, I'm talking about terms - legally, banks can't really offer a true 10 year term but are limited to a true 5 (although they don't tell you that). I got that here: http://www.greaterfool.ca/2013/04/21/rate-roulette-2/

_"But there are other reasons 10-year loans are starting to garner more attention. One is that 1880 law which means all mortgages go open after five years. In this case it means after sixty months you have a borrowing which can be trashed at any time with a relatively small penalty. Most lenders will also allow early repayment of 10-year mortgage with lump-sum payments, or increased monthly payments."_


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## Barwelle (Feb 23, 2011)

@andrewf:

Nope, but close. AFSC. (a similar organization only in Alberta)

@none:

Hmm. You may have a point there regarding that 1880 law.

But I have learned to take anything Mr. Greater Fool says with a grain of salt... he tends to manipulate and misuse data for dramatic effect. For example: "Most lenders will also allow early repayment of 10-year mortgage with lump-sum payments, or increased monthly payments." As if it's a rare thing for terms that are less than 10 years. Well, that's actually true with most, if not all, mortgages. To some arbitrary limit that they choose.


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## Barwelle (Feb 23, 2011)

OK so a bit of quick googling found this:

"For terms longer than five years: if you want to break your mortgage and at least five years have passed, your lender is only allowed to charge three months' interest on the remaining mortgage balance. This may be less costly than other methods of calculating a prepayment charge."

http://www.fcac-acfc.gc.ca/eng/resources/publications/mortgageloan/firsthome/firsthome-5-eng.asp

Good to know, thanks for leading me to that none. Although here it doesn't matter anyway since they don't charge penalties for pre-payment.


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## birdman (Feb 12, 2013)

I'm surprised that they have oferred you a fixed rate for the terms you mentioned. Normally for the reasons mentioned previously, lenders will not go out more than 10 years, The reason for this, in part, is that CDIC only guarantees deposits up to 5 yrs and financial institutions match off the term of their deposits to the term of their loans. However, artificial hedges could probably be established. Suggest you be sure on this though. Anyways, one thing I can tell you is that rates will go up and rates will go down and there is no doubt we are at the low end of the cycle. In my opinion one cannot or should not try to predict rates going out more than a few years at most - just my opinion. However, one possibility may be to have your lender break the loan into "buckets". 1/4 into 5 yrs, 1/4 into 10 yrs, 1/4 into 15 yrs, 1/4 into 20 years. Whatever you think- maybe 1/2 in 5 yrs and 1/2 in 15 yrs. . When I was in the business we did this quite often. One mortgage but say 4 (or whatever) separate loans and terms and interest rates. When my children were recently wrestling with a similar situation on their home they didn't know whether to go floating or fixed and if the latter for what term? They ended up taking some on a variable and some on a 5 yr fixed. There is no reason a lender can't do this.


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## dougbos (Jun 4, 2012)

Lenders offer up to 10 year terms. With 5 year rates jumping about .6% last week 10 year rates are becoming very close to the current 5 year rate.
It is the Canada Interest Act that states that after 5 years of a 7 or 10 year mortgage it can be paid off with a 3 month interest penalty.
CMHC insured loans can be amortized up to 25 years. Conventional mortgages can still be amortized uo to 30 years.


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## Cal (Jun 17, 2009)

none said:


> No, I'm talking about terms - legally, banks can't really offer a true 10 year term but are limited to a true 5 (although they don't tell you that). I got that here: http://www.greaterfool.ca/2013/04/21/rate-roulette-2/
> 
> _"But there are other reasons 10-year loans are starting to garner more attention. One is that 1880 law which means all mortgages go open after five years. In this case it means after sixty months you have a borrowing which can be trashed at any time with a relatively small penalty. Most lenders will also allow early repayment of 10-year mortgage with lump-sum payments, or increased monthly payments."_


Yes, after the first 5 year term, the mortgage basically becomes an open mortgage for 5 more years, therefore no pre payment penalties in the final 5 years of a 10 year mortgage.


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## Barwelle (Feb 23, 2011)

Thanks for the input all. Frase AFSC is a crown corp and is a lender specific to agriculture, so that is probably why they allow a 20-year term. I think we will be going with the split mortgage strategy, with 1/2 in 5-year mortgage, and 1/2 in 20-year.

doug thanks for correcting me, I didn't realize you could have a 30-year mortgage still if it wasn't CMHC insured.


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## mudman (Mar 23, 2011)

Not sure whats best but what I did is went 300k at the 20 years and 200k at 5 years. Rates I see have gone up 0.5% since I did mine. I personally don't believe in 5 years interest rates will be better than 5.5% so if it's a big loan like mine lock some in for 20 years.


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## MRT (Apr 8, 2013)

Cal said:


> Yes, after the first 5 year term, the mortgage basically becomes an open mortgage for 5 more years, therefore no pre payment penalties in the final 5 years of a 10 year mortgage.


A penalty still applies after the 5th year, which is typically 3 months of interest, rather than the usual interest rate differential (IRD) penalty. 

Mr. Turner seems to be using incorrect terminology by saying 'open' after 5 years. 

An 'open' mortgage is exactly that...open. There is no prepayment penalty associated with an open term, meaning you can pay it down (or pay it off completely) without penalty at any time during the term.


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## Barwelle (Feb 23, 2011)

mudman said:


> Not sure whats best but what I did is went 300k at the 20 years and 200k at 5 years. Rates I see have gone up 0.5% since I did mine. I personally don't believe in 5 years interest rates will be better than 5.5% so if it's a big loan like mine lock some in for 20 years.


I have a couple of weeks to decide yet but I probably will split it half and half between 20yr and 5yr. Rates are bound to go up as you say. And if it doesn't, it's 100% open loan so there's an easy out if we find better rates elsewhere.

I looked at some of your older posts, looks like you are renting it out. Is the land cash flow positive?


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## mudman (Mar 23, 2011)

Barwelle said:


> I have a couple of weeks to decide yet but I probably will split it half and half between 20yr and 5yr. Rates are bound to go up as you say. And if it doesn't, it's 100% open loan so there's an easy out if we find better rates elsewhere.
> 
> I looked at some of your older posts, looks like you are renting it out. Is the land cash flow positive?


It is positive before taxes. I rent most out, to busy in the patch to farm, hopefully my kids can one day. I was going to attempt to make hay if it would stop raining.


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## Barwelle (Feb 23, 2011)

mudman said:


> It is positive before taxes. I rent most out, to busy in the patch to farm, hopefully my kids can one day. I was going to attempt to make hay if it would stop raining.


Oh good. This land won't even be positive before taxes, but it is positive before principal payments so we aren't losing money on it. You've taken the smarter route, get a good paying job while letting some other guy take the risk of farming it hehe.

We finally got our hay done last Friday... it has been a real struggle for sure, but good to get it done. Then later that night, we got hail... :rolleyes2:

On a positive note, interest rates have gone down. 3.66% for 5-yr loan, 5.02% for 20-yr loan.


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