This article was found in the April Issue of our Plain Dirt Newsletter. If you have a question about interest rates give us a call at 888.339.3334. Our loan officers are ready to answer any questions you have!
By John Mylin, Loan Officer
If you have a loan with a floating interest rate, you likely noticed that it increased by .25 percent in December 2016. This increase came one year after floating rates were last increased by .25 percent in December 2015. Prior to December 2015, floating rates had not changed since 2008.
Most lenders tie their floating rates to the federal funds rate and commonly refer to the rate on their customer loans as the “prime rate.” The federal funds rate is set by the Federal Reserve, the central bank of the United States. The Federal Reserve consists of a group of individuals nominated by the President and confirmed by the Senate who meet each month to discuss economic issues and decide if an adjustment to the federal funds rate is necessary. Normally a report follows the meeting providing clues as to whether or not a change to the federal funds rate will occur.
Recently the Federal Reserve has indicated that an increase in rates is becoming more likely. Many are expecting two or three increases of .25 percent in 2017 perhaps beginning in March. Janet Yellen, chairwoman of the Federal Reserve was asked recently about her expectations for the federal funds rate. She indicated her expectations are for rates to increase several times a year until 2019 by which time rates may be 2.50 percent higher than today. If this proves to be true, the current prime rate of 3.75 percent would increase to 6.25 percent by the end of 2019. Floating rates at 6.25 percent seem high compared to the rates of the last 8 years, however, compared to the average prime rate of 6.80 percent for the years 1998 -2008, it really isn’t that far from average.
Fixed rates have also been increasing recently. Unlike floating rates that are tied to the federal funds rate, fixed rates are based on the rate a lender must pay in the marketplace to acquire funds. In other words, before Farm Credit provides a 5-year fixed rate for a farm purchase, we determine the cost of acquiring 5-year fixed rate funds from the marketplace. We add a margin to the cost of funds to cover operating expenses and earnings to determine the interest rate to the farmer.
So what has been happening in the fixed rate marketplace? Most look to the 10-year bond rate as a guide to determine changes in cost of fixed rate funds. Bond rates are published in the financial page of most newspapers, so if you would like to keep up to date it is easy to do. On Oct. 1, 2016, the 10-year bond rate was 1.76 percent and on March 3, 2017 it had increased to 2.49 percent. In this 5 month period the rate increased by .73 percent. This increase in bond rates is reasonably consistent with the change in fixed rates available to farmers in the local marketplace. In October of 2016, a 5-year locked rate on a farm purchase would have been slightly less than 4.00 percent. Today a 5-year fixed rate would be between 4.25 percent – 4.50 percent.
While floating and fixed rates do not move in lockstep, they do move in the same direction. Usually fixed rates move in advance of floating rates which is what is now occurring in the marketplace.
The outlook is for interest rates to increase gradually. If you have a floating rate, you may want to think about the impact a 2.50 percent increase in rates would have on your cash flow and whether or not a fixed rate would protect against rising interest rates. If you have a fixed rate that expires in the near future, you may want to consider re-locking the rate now rather than later when rates may be higher.