How Much Can I Borrow?

This seems like a simple question, and it’s one I hear occasionally from borrowers. It is actually very complex and one that should properly be worded, “How much should I borrow?” While Ag Credit is in the business of loaning money for agricultural or rural home purposes, one of our biggest responsibilities is to also let a borrower know when they cannot afford to borrow as much as they would like.

To answer these questions for larger loans, such as the purchase of real estate, your Ag Credit loan officer looks at your complete financial picture to determine whether a loan request is viable. Ag Credit is a relationship lender, meaning we want the borrower and lender to establish a relationship with each other of trust and understanding. In order to do this as a lender, we look at the 5 C’s of credit: Character, Conditions, Capital, Capacity and Collateral.

CHARACTER is somewhat self explanatory, referring to the character of the borrower. Because many of the Ag Credit loan officers have lived in the same community much of their lives, often times the loan officer knows, or has known, the borrower for many years. Character can also be determined by a borrower’s past history of paying debts.

CONDITIONS simply refers to the type of request being made, how the loan will be structured and the interest rate being charged. It can also refer to any other details or specifics of the loan that may be unique to the situation. Most people are probably more familiar with the remaining 3 C’s of credit; however, you possibly may not know them by the names used here. Within these three C’s is where a loan officer will complete most of the analysis in order to determine if a loan request is viable.

CAPITAL is another term used to mean “financial position” of the applicant. In order to determine capital, a loan officer will ask you to complete a balance sheet. The balance sheet is a snapshot in time of all of the borrower’s assets (what you own) and liabilities (what you owe). When listing values of your assets, it is best practice to show the actual value as what it is worth as of the date of the balance sheet, not what was actually paid for the asset when purchased. After you list all of your assets on the left side of the balance sheet and liabilities on the right side, the loan officer can take the value of total assets minus the total liabilities to determine a borrower’s net worth, also known as the owner’s equity.

Owner’s equity is simply the value of assets that are debt free. It is always beneficial to try to complete a balance sheet at the same time each year, preferably at year-end. By doing this, you can track your financial progress more accurately from the change in net worth.

Completing the statement at year end will also be helpful to the borrower by having their inventories completed as of the year end for tax preparation purposes.

Both assets and liabilities are further broken down into current and non-current assets as well as current and non-current liabilities. Current assets are liquid assets that will be sold or converted to cash within 12 months. Examples of current assets would be savings, feed inventories, crop inventories and feeder livestock that are sold within 12 months. Current liabilities are debts that are due within the next 12 months. These would be operating lines of credit, credit card debts, open accounts at businesses and the principal portion of any term payments due in the next 12 months.

There are some key ratios loan officers look for on a balance sheet such as working capital margin. This is simply the total current assets minus the total current liabilities. A positive working capital margin is important because this is the borrower’s “reserves” in the event of a down turn in markets or other difficult times. This is an indicator of liquidity.

Some key ratios and figures to keep in mind from the balance sheet are:

CAPACITY is the fourth “C” of credit and refers to the earnings of the borrower and the capacity, or ability, to service debt. Ag Credit will often request a copy of the borrower’s farm records or tax returns to document earnings and create a trend over multiple years. When we analyze a borrower’s earnings, we look at gross farm income, minus farm expenses, to get the net farm earnings. Off-farm income, if any, is then added to this figure to determine total earnings.

From total earnings, we subtract the amount paid in income taxes, as well as a figure for family living. Family living is often overlooked, and under estimated, by borrowers. This figure includes any living expenses not included in the tax returns, such as food, clothing, home utilities, charitable contributions, etc. The net figure after subtracting taxes and family living from net earnings is referred to as the Capital Debt Repayment Capacity.

From the Capital Debt Repayment Capacity, we then subtract the amount of principal payments due in the next 12 months to determine a bottomline margin. This margin is how much the borrower actually had left after all expenses and payments are paid. If the numbers are accurate, the margin should correlate to the amount of increase, or decrease, in net worth shown on the borrower’s balance sheet. Preparing an annual financial statement each year helps provide the most accurate information to your lender.

The final “C” is COLLATERAL. When acquiring a loan, Ag Credit will often ask you to pledge something for collateral to secure the debt, depending on the type of loan and terms. For a longterm loan over 10 years, first mortgage real estate is required for collateral. For shorter-term loans, equipment and/or cattle may be used for collateral depending upon the situation. For most loans, Ag Credit will loan up to a certain percentage of the collateral value depending upon the terms of the loan, financial strength of the borrower and condition of the collateral. If chattels (livestock, equipment or vehicles) are used for collateral, a periodic inspection by the loan officer will likely be requested.

The question of “How much can I borrow?” should better be asked as “How much should I borrow?” As you can see, there are a lot of variables as they pertain to financial strength, earnings, collateral offered as well as the borrower themselves and purpose of the loan. Sometimes, Ag Credit’s most important job is to analyze all of the pieces to the puzzle and then counsel the applicant that it may not be in their best interest to borrow the funds based on what is known from their finances.

As mentioned before, Ag Credit wants to create a relationship with our borrowers. To have an effective relationship means not only making good loans, but also advising the borrower when they may be asking to borrow at a level that could potentially be detrimental to both the borrower and the association. The most important thing to remember is to never hesitate to ask your loan officer questions about your financial position or the borrowing process. 

About the Author: 

Joe Goggin is a Principal Loan Officer in the Lexington Ag Credit Office. Joe has over 25 years of lending experience and has also worked in the Danville and Stanford Ag Credit Offices.

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