Obtaining Finance and
Credit: Unit 6
By:
Eslon Ngeendepi
EAR212s 2013
OBJECTIVES
Define capital, credit and loan.
 Define the types of loans.
 List the different sources of credit for farmers.
 Explain the credit evaluation process for farmers.
 Explain the terms and conditions of loans.
 Explain the different types of interest rate and
calculations.
 Explain the concept of loan maturity and collateral.
 Define the debt repayment capacity.
 List the terms of repayment.

1. CAPITAL, CREDIT AND LOANS
Agricultural Capital: Goods used to produce
other goods which generate income over extended
periods of time e.g. equipment, house & livestock.
 Farm credit: Resources/part of capital/money
used to purchase assets or operate a farm.

TYPES OF CREDIT OR CAPITAL
 Real
estate
capital
or
credit:
Credit/capital used to purchase farm land,
real estate or add improvement to farm
property/assets.
 Working capital or credit: Capital used to
purchase productive inputs that are used for
more than 1 year including breeding stock,
equipment and machinery.
 Operational capital or credit: Capital
used purchase inputs that are consumed in
the production process e.g. seeds, fertilizer,
etc.
PRODUCTIVE VS CONSUMPTION CREDIT
Productive Credit: Form of credit used to
increase production or income or used to
purchase land, livestock, equipment, seed,
fertilizer, etc.
 Consumption Credit: Credit used to purchase
consumable items used by the family and does
not contribute to business income. E.g. credit for
food, clothing, household goods etc.

TYPES OF AGRICULTURAL LOANS OR
CREDIT



Short-term loans
 Operating loans or credit: Loans for short-term seasonal
needs, often for year or less & are to be paid from that years
production. E.g. Seed, chemicals, fertilizers, feeder stock.
Security is often a lien on products produced.
 Open account credit or line-of-Credit: With suppliers or
banks that specifies the timing of disbursement and payment
of loan. Two types:
Intermediate Credit or loans (2-7 years)
 Credit for depreciable assets and capital investment (farm
equipments, building, etc) or refinance debts incurred for
capital purposes to be repaid over a period of 2-5 years or more.
Collateral or security: Crops or real estate.
Working capital loans: For longer term assets breeding stock,
building renovations. Repayment period: 5-7 years. Security or
collateral: Mortgage on personal property financed.
Long-term Loans, Real Estate Mortgages or Contract
Financing: Loans to acquire, construct, improve land &
buildings or to consolidate other loans. Repayment period:
Longer than 10 years. Security: Lien on real estate.
SOURCES OF AG FINANCING
There are four basic sources of
Agricultural financing.
 Private Financing
 Commercial Lending
 Farm Credit System
 Farm Service Agency
 Insurance firm
PRIVATE FINANCING
 If
available this can be your best option as
it will allow for more flexibility and less
restrictions.
 In private financing you only have to
convince yourself or usually a friend or
relative that your proposal is sound and
secure enough to invest.
 This can also be less restrictive. This can
be a good source of financing in
conjunction
with
other
commercial
financing providing the much needed
collateral position they will require.
COMMERCIAL LENDING






This would include banks, credit unions, credit cards etc.
Banks would be the most common source of credit to the Ag
sector.
The first bank to contact is always your own bank. They
will know you the best and are more likely to help if you
have a history with them.
The problem is that more and more banks are moving away
from Ag lending. You may have to go out of your area to
find a bank that would do Ag financing. When applying for
a loan you need to have done your homework.
When you present a plan to your bank, have it supported
with realist projections including a solid marketing plan.
The first impression will be the lasting one. If you are
shooting in the dark it will be apparent and your success
unlikely.
E.g. Agribank and the 4 other commercial banks in
Namibia
FARM CREDIT SYSTEM
 This
would be the Federal Land Bank or
Production Credit System. They are found in
all rural areas and are exclusively involved in
Ag Credit.
 They are not part of the government although
there is some oversight.
 They are producer owned so can provide
better rates and terms on real estate loans
and have a complete portfolio of real estate
and operating type loans.
 With their total involvement being in Ag
lending they will have a good understanding
of what you want to accomplish.
FARM SERVICE AGENCY
This is an agency of the U.S. Government that
provides assistance and support to farmers.
Within FSA there will be the farm loan
department and they will have representation in
each region throughout the U.S. They are able to
make direct loans to farmers or work with a
commercial lender in providing guaranteed loans.
 This will allow lenders to make loans that they
are not completely comfortable with due to risk
or uncertainty since the loan is backed by FSA.
 The major advantage to FSA is that they can
make loan with little or no equity and are
designed to help new farmers and ranchers get
into the business of Agriculture.
 The drawbacks are that you must meet certain
eligibility requirements and they have limited
funding.

CHOOSING A LENDER
Borrower need to look for lender offering best
deal possible.
 Type of financing needed determines the type of
lender a borrower chooses.
 Short-term
loan
lenders:
SourcesComm/Agric banks, relatives, input/output
dealers, cooperatives. Etc.
 Long-term loan lenders: Sources- Agric
banks, insurance companies or cooperatives.
Borrowers need to identify lenders with whom
they can establish long term working
relationship with.

LENDERS REPUTATION
Honesty & fairness: Lenders must have a
reputation of fairness & honesty, success and
value the borrowers business.
 Agricultural
knowledge:
Lenders
must
understand agriculture and the risks involved in
agriculture.

APPRAISING LENDER’S POLICY ON
AGRICULTURAL LOANS
Loan terms: Terms offered should match the
seasonal nature of farming.
 Interest rate charged: Must be in line with
agricultural risk and prevailing cost of capital
elsewhere.
 Security or collateral requirements: Must be fair
and competitive.
 Service fees: Granting and servicing the loan
must be reasonable and fair.
 Eligibility requirements: A lender’s eligibility
requirements and speed of processing loans must
be assessed.

Appraising lender dependability and financial
health: Borrower asses lenders financial health
because financial difficulties are not the best source of
agricultural loans. The agriculture sector requires
stable credit sources.
 Appraising a lender’s experience in agriculture:
Lenders must clearly understand problems in
agriculture particularly problems the borrowers is
likely to face. Lender must be able to provide borrower
with advice when needed.

LENDERS EVALUATION OF THE
BORROWERS

Lenders will carefully consider borrowers ability
to manage their enterprise and repay the debt
before the loan is given.
LENDER’S EVALUATION OF BORROWERS

Borrowers need to consider the following when
choosing a lender:





Their own needs
The lenders reputation
The lenders policies
The lenders dependability
The lenders experience in agriculture
APPLYING FOR A LOAN

The following documents must be handed when
applying for a loan:
 (a) Need (what) for the loan: Information on
what they need the loan for e.g. if loan s needed to
purchase a form equipment, information on prices
and description of equipment are needed.
 (b) Why the loan: Information on why they need
the loan and how they will repay (projected budget
needed).
 Up-to-date Financial Statement: Listing the assets
and liabilities. Financial history and farmers
record-keeping system must be provided.
WHEN APPROVING A LOAN LENDER MUST
CONSIDER
The individual borrower
 The purpose of the loan
 The financial condition of the borrower
 The repayment ability of the borrower
 The borrower’s collateral- the asset to secure
the loan.

TERMS AND CONDITIONS OF LOANS

Borrower need to understand the loan
agreement, loan terms and conditions, i.e.
Interest rate, fees, collateral, methods of
receiving funds, repayment time and periodic
repayment amount, etc.
TERMS & DOCUMENTS USED IN SECURING LOANS


Interest rate: Price of using borrowed money.
Determinant of interest rate:
 Money supply: M1 or M2
 Demand for credit: ↑demand for credit the ↑rate.
 Risk (from borrower to lender): The higher the
borrowers risk the higher the rate.
 Cost of making and servicing the loans: High cost of
servicing loan means the higher rate the lender will
charge.
 Funds rate (Repo rate): Rate charged by BoN on
Comm.Banks & other fin instit.
 Prime rate: Rate that financial institution charge their
biggest and best customers. Prime based on Funds rate
(Repo rate).
TYPES OF INTEREST RATES
Fixed interest rates: Loan carries the same interest
rate until the loan is paid off.
 Adjustable interest rate: Rate that can be changed at
intervals as specified in the loan agreement e.g. 6 years
loan, interest can be can adjusted once every year.
 Variable interest rate: Rate changes based on the
market interest rate a specified index or at the
discretion of the lenders. Linked to the specified index
rate and lender adds a margin to the index rate to
determine interest rate.

Interest rate index: Variable and adjustable interest rate
are linked to interest rate index. Indices used by lenders
include their average cost of funds, prime rate charged at
money markets.
 Margin: Refers to the % points that the lender adds to the
rate index to determine the rate charged to the borrower.

VARIABLE INTEREST
In recent years, it has become common for lending
institutions to adopt a variable interest rate policy.
 Typically, the interest rate will be stated on an annual
basis and will not change more often than once each
month. If interest is calculated on the remaining
balance method, it can be calculated in a way similar
to the process for partial year loans.
 For example, if the interest rate was 12 percent for 2
months, 13 percent for 3 months and 14 percent for 7
months, the annual interest amount is: I = A x 0.12 x
(2 / 12) + A x 0.13 x (3 / 12) + A x 0.14 x (7 / 12)
 If applied to the add-on or discount methods, a new
calculation would have to be made each time the rate
changed.

INTEREST RATE CALCULATIONS

Simple Rate Method: Cost of loan is proportional to interest
rate.
 Interest amount paid= Principal (loan)x rate x Time
(years)

Example 2:
P x r x T e.g. I= (N$4500) (0.095) (6)




I= N$2565.00 per year
Example 2:
Assume you take a loan of N$23 000 for 3
months at an interest rate of 12%.
Calculate the interest amount paid.
Unpaid Balance Method: Interest amount is based on the
unpaid loan balance.

Discount Method: Interest cost is deducted from loan at
the beginning of the term, making interest rate higher than
it appears as the borrower does not have the use of the full
loan amount.
The interest is subtracted from the loan amount and the borrower
receives the balance.
 The total interest charge is: I = A (Actual loan) x i (interest rate)
x N (time)


The amount the borrower receives is: L = A - I
Where: L=loan proceeds and
 Periodic payment is: Bn = A / N



Using data given as N$3,000 loan amount, 6 percent
annual interest rate, over 2 years), the total interest charge
is again N$360: I = $3,000 x .06 x 2 = N$360
The borrower would receive N$2,640:
L = N$3,000 - N$360 = N$2,640
 Periodic payment: repay two instalments of N$1,500 each:
 Bn = N$3,000 / 2 = N$1,500


Equivalent or True interest method: This method
gives the actual interest borrowers pay as it takes
service charges into account.

Formula= (Total charges/one-half the loan) x no. of
payments/ no. of years) x (1/ no. payments + 1)
ACTIVITY 1

Suppose that a mahangu farmer decides to
borrow N$50,000 for 2 years. The interest and
service charges are given as 30% of the initial
loan amount. The loan is payable semi-annually
in year 1 and quarterly payments are to be made
in year 2.
i.
Obtain the total charges.
(2)
ii. Calculate actual interest rate the farmer
pay? Show all you calculations including the
formula used.
(8)
LOAN MATURITY & COLLATERAL
Maturity: Time until the loan is fully due and
payable. Shorter maturity result in lower total
interest payment and higher loan payment over
the life of the loan, but loans with longer
maturities will have lower loan payment.
 Collateral or security: This refers to the assets
borrowers pledge as security in loan transaction.

Long-term farm real estate loan: Collateral is a
deed of trust on a tract of land or a house for farm real
estate loans or a mortgage on the property.
 Operating and intermediate-term loan: Collateral
is a security agreement. For intermediate-term loans
for equipment or facilities, the security or collateral
are the assets being purchased. Operating loans are
usually secured by current assets.
 Unsecured short-term loans: When producers with
a good reputation obtain a short term loan without any
security, the loan is an unsecured loan or a signature
loan.
 Repayment penalties: A repayment penalty is a fee
charged by a lender when a loan is paid prior to its
maturity.

DETERMINING THE AMOUNT OF CREDIT
TO USE IN FARMING

When borrowing money the following sound credit
programmes must be considered borrower:
Will the net returns from the loan cover its costs and
repayment?
 Will the borrower have adequate income to meet the terms
of repayment, both interest and principal, when due?
 Is the risk-bearing ability of the borrower sufficient to carry
the risk and uncertainty involved with the loan.

DEBT-REPAYMENT CAPACITY
Illustrate the ability to meet loan payments as
scheduled.
 Farmer should consider the amount of funds
available to repay the loan or debt and the terms
of repayment.
 Assessing repayment capacity must include all
income and expenses expected during the loan
period.

AVAILABLE FUNDS TO REPAY LOANS

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Funds available to pay debt obligation (net cash
income).
Net cash income from the farm must be higher than
cash operating expenses.
Net cash income is the funds available to pay
personal living expenses, personal taxes, debt
obligations, capital expansion and savings.
Living expenses and taxes have a high priority, thus
allowances must be made for these before
determining funds available for principal payments.
Interest on debt is considered an annual operating
expense, thus the net cash income is reduced by
interest payments.
Cash farm income (Livestock and N$ 65, 000
product sales, crop sales)
Cash farm expenses (labour, feeds, (N$ 46, 000)
fertilizer, repairs, taxes, interest
repayment etc)
Net cash income
N$ 18, 000
Family living expenses
N$ 12, 000
Funds
available
repayment
from
business
for
the
loan N$ 6, 000
farm
TERMS OF REPAYMENT
There are two repayment terms:
 Time: Length of time over which the loan is to
be repaid.
 Periodic amount: The amount to be paid
periodically.
 Two major factors that affect the terms of loans
on the debt load to be repaid are:
 Years for repayment
 Interest rate
Extending years of repayment increases the debt
load that can be carried. Increasing the
interest rate decreases the debt load that can
be carried.

REPAYMENT TIME

Refers to the time it will take to repay the loan in
full. The following methods are used:

Time for short-term or operational loans:


Time for intermediate-length loans:


Borrowers billed at the end of the month.
Repayment time varying from 2-7 years.
Time for budgeted loans:

Lender and borrower determine in advance when loan
funds will be needed and the timing for repayment. Funds
are advanced as needed and repaid as products are sold.
These loans give flexibility in managing cash flow and
borrowers pay only for funds actually used.
PERIODIC REPAYMENT AMOUNT




Refers to an amount to be paid periodically until the
loan is fully paid.
Payments on line-of-credit financing generally occur
when the borrower has surplus funds.
For intermediate and long-term loans a payment
schedule is usually used that specifies principal and
interest payments over the lifespan of the loan.
The methods of repaying loans are given as:
The straight-end payment (interest payment): Interest
payment and principal paid at the expiration of the loan.
 Partial or balloon payment: Fixed principal payment each
month during the lifespan of the loan. Payment do not
liquidate the principal during the repayment period, hence
a large amount, a balloon payment is due at the end of the
loan lifespan to finish paying the principal.

SUMMARY

When developing your
operating plan, be creative
in your approach to
obtaining financing. Look
at the possibility of using
more than one source to
provide the best plan.
Be
Creative,
Adventurous
and
Persistent
in researching all
financial possibilities.