01 Dec Fixed Rates

By Deb Purvis

FIX YOUR RATES, AND YOU FIX YOUR CUSTOMER MARGIN

Brad mentioned in his newsletter that you should refrain from fixing any debt until you have conducted a more widespread review of your financial position.

Here’s why.

Let’s go back to the beginning of how banks determine the interest rate you should pay on your loan.

The bank calculates your interest rate on both variable and fixed-rate loans using the quoted ‘base rate’ plus or minus your ‘customer margin’.  How do they determine your ‘customer margin’?  By considering the ‘Five Cs’.

• Capacity
• Character
• Capital
• Conditions
• Collateral

I don’t have to tell you how variable the financial results of agriculture can be and how often the 5C’s can change in your business. Once you fix a loan, you set your customer margin. Over time your position may have improved, but the bank has failed to re-grade your risk and reduce your customer margin.  And, as you will notice in the case study below, even if you request a review, it doesn’t always result in the bank making a change to your margin.

CASE STUDY – $3,500,000

This RSP client went to their existing bank and asked whether they could do better on their current variable rate and requested a quote for fixed rates.

Their bank declined to improve the client’s customer margin.

The clients then engaged RSP to conduct a tender to other banks plus their current bank.  The result shows that ensuring you have the lowest ‘customer margin’ before fixing rates will make a big difference to the long term interest that you pay.

Tender Results

Current Bank

Variable – 2.45% (a reduction of 1.16% on their customer margin)

Fixed (2 years) – 3.04%

Fixed (5 years) – 4.10%

Alternative Bank

Variable – 1.9%

Fixed (2 years) – 2.55%

Fixed (5 years) – 3.45%

Let’s say the client fixed $1 million for two years and another $1 million for five years.

Current Bank                                    Alternative Bank

Variable (1 year)   $36,750                   $28,500

2 years                   $60,400                   $51,000

5 years                   $205,000                $172,500

$302,150                   $252,000

That decision alone would have cost them over $50,000.