The last couple of years have been good for dairy producers. Milk prices remained strong throughout 2004, and generally favorable milk prices continued through most of 2005.

However, during that same time, interest rates also have risen. In July 2003, the Federal Reserve discount rate (the interest rate the Fed charges on loans to banks which is a key driver of interest rates in U.S. financial markets) stood at 2 percent. As of November 2005, the Fed’s discount had risen to 5 percent.

This increase in the Federal Reserve’s discount rate is working its way through financial markets, and has started showing up in the interest rates paid on farm loans. According to the Federal Reserve Bank of Chicago’s AgLetter in September of 2003, the average interest rate for farm operating loans was about 6.5 percent. By September 2005, this interest rate had risen to slightly above 7.5 percent.

Higher interest rates translate into higher payments. Producers need to be mindful of the impacts that rising interest rates will have on their repayment obligations and develop budgets and spending plans that account for increasing loan payments.

Estimate the cost
Using the table at right, you can easily learn to estimate how much your loan payment will change due to variations in interest rates. This table shows the amount by which an annual payment on $1,000 of debt, to be repaid in a specified number of years, will change with various changes in interest rates.

Let’s walk through an example. Start with the column on the left. Find the line listing a 10-year loan. Now, follow that line to the right until you get to the column where the interest rate changes from 6 percent to 7 percent. This shows your payment would increase by $6.51 per $1,000 borrowed. So, if the total outstanding balance on the loan was $200,000, the total change in the payment would be $1,302 (200 x $6.51).

The payment adjustment table shown below also can be used to estimate the increased payment for interest rate changes in excess of 1 percentage point. To do that, you add together the increase in cost reported for each percentage-point change in interest rate. For example, on a 20-year loan when the interest rate goes from 6 percent to 9 percent, the total increase in cost per $1,000 borrowed would be $22.36. According to the chart, the reported changes for the interest rate changes of 6 to 7 percent, 7 to 8 percent, and 8 to 9 percent are $7.21, $7.46, and $7.69, respectively. Added together, they total $22.36.

Do some planning
Rising interest rates will have an impact. Dairy producers should adjust their budgets and spending plans so they can handle the higher loan payments needed to cover higher interest charges. Failing to do so could result in some financial stresses later in 2006 -— particularly if milk prices trend downward in the coming year, as many expect.  

Bruce Jones is a professor of agricultural economics and an extension farm management specialist at the University of Wisconsin.