Fixed vs variable loans in a rate-cutting era

REGINA, SK, June 10, 2024 /CNW/ - With the Bank of Canada lowering its key interest rate, now is a good time for farmers, agribusiness operators and food processors to begin reviewing their financial strategies says FCC's Manager of Economics, Krishen Rangasamy.

On June 5, the Bank of Canada lowered its overnight target rate by 25 basis points to 4.75 per cent from 5.00 per cent. The overnight target rate is used to set financial institutions' prime rate and influences variable mortgage rates. When the overnight rate changes, the prime rate typically changes by the same amount.

"This key interest rate has been increasing since March 2022. With inflation having peaked and now heading towards the Bank of Canada's two per cent target, it makes sense for the central bank to provide relief to a struggling economy by lowering the overnight rate," Rangasamy said. "With this decrease it is a good time for producers, agribusinesses and food processors to review their financing options, especially as FCC Economics forecasts two additional interest rate cuts in the second half of this year."

A recent analysis by FCC assesses the costs and benefits of taking out a fixed or variable-rate loan, considering today's economic environment and different forward-looking scenarios. The analysis shows that if the Bank of Canada were to drastically cut rates, borrowers could benefit from lower payments over a five-year period if they opt for a variable rate loan. But if the Bank of Canada instead opts for a gradual approach in cutting interest rates, there would be little difference between taking out a fixed-rate or variable rate loan with respect to total payments over a five-year period. Yet, a fixed rate option would bring predictability in managing future interest expenses.

"Borrowers should think carefully about their personal risk level given the pros and cons between fixed and variable rates," said Rangasamy. "An option that borrowers can consider is diversifying their debt portfolio by using a combination of fixed and variable rates. This allows them to benefit from both types and to spread their risk over different time periods. For example, a borrower could have a variable rate loan for a short-term project, and a fixed rate mortgage for a long-term investment."

However, diversifying also adds complexity to managing multiple loans or mortgages, and may require more attention and monitoring. Therefore, borrowers should consult with their financial advisors and lenders to find the best solution for their specific situation and goals.

Rangasamy said that the interest rate cut is a good opportunity for farmers, agribusiness operators and food processors to take advantage of the lower borrowing costs, but he also cautions them to be prudent, and to have a contingency plan in case of unexpected events or changes in the market.

"There are still risks with regards to both the global and domestic economies which, if they materialize, can have repercussions on Canada's inflation and therefore interest rates. That's why it's important to stay informed, stay flexible and stay prepared," Rangasamy said.

Learn more about interest rates by visiting FCC. Producers who want to review or establish their financing strategy can contact the nearest FCC office at 1-800-387-3232.

By sharing agriculture and food economic knowledge and forecasts, FCC provides solid insights and expertise to help those in the business of agriculture and food achieve their goals. For more economic insights and analysis, visit FCC Economics at fcc.ca/Economics.

FCC is proud to be 100 per cent invested in Canadian agriculture and food. Our employees are committed to the long-standing success of those who produce and process Canadian food. FCC provides flexible financing and capital solutions, while creating value through data, knowledge, relationships and expertise. FCC offers a complement of financial and non-financial products and services designed to support the complex and evolving needs of the industry. As a commercial Crown corporation, FCC is a stable partner that reinvests profits back into the industry and communities it serves. For more information, visit fcc.ca.

SOURCE Farm Credit Canada