Whether you’re a beginning farmer or established producer, access to capital is not only critical for securing farmland, but to cover the large capital outlays needed to fund yearly operating expenses such as seed, fertilizer and other inputs.
However, unlike other businesses that can rely on regular cashflow streams, income and operating expenses don’t always align on a farm or ranch. That’s why many producers use an operating loan, or line of credit,
to help supplement variable cash flow of the annual production cycle.
In this article we explain the difference between a line of credit and other loan types, how a line of credit works and the benefits of using one.
What’s the difference between a traditional loan and a line of credit?
Loans and lines of credit are two different financing options borrowers can leverage to help manage working capital while maintaining adequate cash on hand. With a traditional loan, the borrower has access to the amount loaned in one lump sum and principal and interest payments are made until the debt is paid off.
A line of credit, on the other hand, gives borrowers access to a preset borrowing limit that can be used, paid back and borrowed again. The borrower has continuous and repeated access to the line of credit while it is active, and interest accrues only on the funds that have been drawn.
While a loan is based on a borrower’s specific need, credit lines can be used for multiple purposes or farm activities. Once a line of credit is approved, the funds are deposited – usually in an account – and cash withdrawals can be made against the line of credit as needed.
Typically, there are no limits to how many times the funds can be accessed or how much is drawn, making lines of credit a flexible financing method for managing ongoing operational costs, continued cash flow and other production decisions.
How does a line of credit work?
Like a loan, approval for a line of credit is dependent on a borrower’s repayment capacity and credit history. Although a line of credit can be used and paid back more flexibly than a loan, a lender will still expect a business plan or projection of how the money will be repaid.
Depending on the lending institution, collateral may be required to secure the line of credit. Unsecured lines of credit are not backed by any form of collateral. Whether a credit line is secured or unsecured will impact the rates and terms offered.
Generally, secured lines of credit will have a lower interest rate because lenders consider them to be less of a risk compared to an unsecured credit line. Similarly, secured lines of credit may have longer term options that can be extended upwards of 10 years.
Additionally, borrowers also have the option to choose between a revolving or non-revolving line of credit. The main difference between these two types of financing arrangements is that with a non-revolving line of credit, the pool of available funds does not replenish after payments are made.
When a non-revolving line of credit is paid off in full, the account is closed. A revolving line of credit remains open until the borrower chooses to close the account.
What are the benefits of using an operating line of credit?
A line of credit is a valuable financial resource to keep your operation moving forward, especially during months of irregular income. As a borrower, some of the benefits of using this financing method include:
- Flexible borrowing against your credit line – As a flexible financing tool designed to help you with your short-term borrowing needs, a line of credit allows you to make easy cash withdrawals while only paying interest on what you withdraw.
Interest rates for most operating lines of credit are adjustable rates based on market indexes, but some lenders also offer fixed-rate options.
- Repay your credit line without a fixed schedule – Annual operating loans, or lines of credit, are generally repaid within 12 months or when commodities are sold. For example, a line of credit taken out to cover crop input expenses is typically paid back using the profits from the sale of that crop.As long as you are able to make the minimum payments, you can pay off the credit line over the agreed upon terms.
- Build a relationship with your lender – Beyond increasing your access to capital when it’s needed, another benefit of using a line of credit is building a strong relationship with your lender. At renewal time, your annual meeting with your lender can deepen the understand of your operation and borrowing needs. Establishing a foundation of trust between borrower and lender can make all the difference when unexpected challenges arise.
How can I get started with an operating line of credit?