Today on your way to work you drove past a “For Sale” sign for a neighbour’s farm. And now you’ve spent the rest of the day daydreaming about how cool it would be if you could buy that farm. Or any farm really. You read the purchase guide but you still are not quite sure what your budget is or should be. No worries, with a few simple calculations, we can figure out your budget and what kind of farm price tag you can afford.
The Quick and Dirty Method
If you just want to very quickly determine approximately what your farm budget is, take your net paycheck per month and multiply by 36%. This amount is the maximum payment per month you can afford without going into further detail. Once you have this value, you can either just play around with the FCC loan calculator to how the payment on that farm you’ve been eying compares to your monthly maximum or you can multiply your maximum payment by the present value factor of 14.094 (5% over 25 years) or 12.462 (5% over 20 years) which gives you a guesstimate of what you can afford. To afford a $500,000 mortgage which has a $2,908 monthly payment at 5% over 25, you need to be bringing home more than $97,000.
That method works if you are still at the vision stage, daydreaming. If you want to buy more farm than your off-farm income can cover, you will need to go into much greater detail regarding what you can and cannot afford. You’ll need solid income statements from your existing farm operation or if you are buying an on-going operation, their financials. If you are buying an existing operation, it would be in your best interest to have an accountant sit down with you to look over all of the statements and your budget.
Determine your own income
First, take your income tax return (and your partner’s if you are doing this as a team) and find out your gross pre-tax income. Look for Line 150 (total income). This amount includes anything on a T4 as well as any farm income if you already have an operation. Next look for line 435 (total tax payable). The net difference between the two numbers is your after-tax income. Write these three numbers down, you will need them several times. Use the following steps to
- The maximum gross debt service rate is 39% and the maximum total service debt rate is 44%. The debt service rate is the percentage of your income that is needed to pay your debt payments. Assuming you have no other debts, start by using 40% as long as you intend to have an active farming operation right away. Take your gross pre-tax income and multiply it by 40%. This is your maximum total payments per year.
- Look up your lender’s interest rate and the Bank of Canada’s 5-year benchmark rate (currently 5.19%). Add 2% to your lender’s interest rate. Whichever is the highest interest rate is the rate you will use for your calculation. This is the stress test that came into effect in January 2018.
- Use a loan calculator like this one to determine what the mortgage total will be. Remember that if your mortgage is amortized over 25 years and you make monthly payments, the mortgage has 300 payments.
- Now that you have the mortgage amount, divide it by 80%. This is the maximum purchase price you can afford with a 20% down payment.
Let’s put this calculation into practice, what does the maximum purchase price really mean? Since tax rates vary by province, I will use the Ontario combined rate to get an after-tax income amount. I will use two different scenarios to give you an idea of the numbers you should consider.
Buddy has an off-farm salary of $45,000 at the local feed store. He has started up his own farming operation raising veal calves in a rented barn which brings in a net income of $15,000 per year. This brings Buddy’s pre-tax income to $60,000. Buddy has been living in his friend’s basement and saving every penny. He now has saved up $50,000 and his grandfather is willing to help him with another $50,000 bringing his potential down payment to $100,000. Buddy’s after-tax income is $48,000.
Jane and John met in agriculture college and want to have a farm together. They’re working crazy hours and bring home $110,000 together before taxes. After taxes, they have $75,000. They have been very frugal and saving up their hard-earned cash. With $150,000 in their bank account, they feel they are ready to buy their dream farm.
For math’s stake, Buddy, Jane and John are all looking to purchase a farm in the same region, and none of them has any other debt. The bank’s posted lending rate is currently 4.4% interest for a farm. A bit of research shows us that average property taxes in the region are typically around $3,000, utilities are $400 per month and insurance is $3,000. That works out to $10,800 annually.
Using the total debt service rate of 40%, we get $60,000 x 0.40 = $24,000 for Buddy and $110,000 x 0.40 = $44,000 for Jane and John. This is how much they can pay annually on the mortgage without getting into serious financial distress. This works out to a monthly payment of $2,000 for Buddy and $3,660 for Jane and John.
Buddy can afford $298,000 and John and Jane can afford $547,000. Adding down payments on top of that at the minimum 20%, Buddy can make an offer up to $372,500 and Jane and John can offer up to $683,750.
Based on our math above, Buddy has $48,000 after tax. The property taxes, utilities, and insurance add up to $10,800. His payments will be $1,632 if he gets a mortgage of $298,000 at 4.4%, which works out to be $19,584 in payment per year. This means Buddy has left with $17,616 to live on. Since he already has the veal business, Buddy knows that he can raise and sell twice as many calves with his own farm. The farm Buddy would like to buy is $400,000. He has the down payment to do that, so he would need a mortgage for $320,000. This would bring his payments to $1,753 per month and the total to $21,036. His veal calves need to bring in an extra $1,452. He would be left with $20,000 of the $100,000 savings to cover closing costs and setting up the new farm. Given that he is currently making $15,000 net income and the new farm allows him to double his production, it is probably feasible for Buddy to buy the $400,000 farm.
The opposite is true for Jane and John. They can afford a farm for $683,000 but should they spend that much? The down payment will be $136,000 of their saved $150,000. They would have a monthly payment of $2,997 at the bank’s rate of 4.4% on $547,000. With an after-tax income of $75,000, once Jane and John pay the property taxes, utilities, insurance and the mortgage payments, they have $28,235 left to live on and start their farm. They would have $4,000 left of their savings if the closing and moving costs are $10,000. Since they got their savings by working crazy hours, chances are one of them will have to cut back to also run the farm which would reduce their income. Buying at the maximum of their farm purchase budget would severely restrict John and Jane’s ability to start their farm. If they bought a farm like Buddy’s ($400,000), they would be left with $43,164 of their income and $60,000 of their savings. This would give them a much better place to start.
If you are looking at an ongoing operation, a good strategy to think about would be how much product do you have to deliver to pay each bill. For example, if you are selling beef calves and each calf costs you $500 to raise and you get $650 when you sell it, how many calves do you have to sell to make that mortgage payment? The difference between the cost to raise and the price you receive is the contribution margin. In the scenarios, Buddy would need to figure out exactly how many extra calves he needs to sell to get the extra mortgage payment paid.
As you can see with the two scenarios, Buddy can afford to reach a bit over his budget because he already has a farming operation. He is mostly restricted by the amount of savings he has. Banks also have their own calculations. You want to be realistic in the income that the farm produces and figure out the contribution margin, especially if you intend to farm full-time right away. The bank is not going to look out for your financial well-being beyond your ability to pay them. All of these numbers are guestimates at best, they are intended to show you how to figure out your farm purchase budget yourself.
I hope this helps you establish a starting point for your farm purchase budget. The three things you should always consider is:
- The mortgage payments and how much of your cash flow they will take as well as what happens when interest rates rise.
- The amount of the down payment you have saved up. Just divide your savings by 0.20 and that will give you the purchase price you can look at.
- Don’t forget closing and moving costs as well as how much money you will need to start your farm.