The Department of Agriculture’s Farm

Service Agency (FSA) provides direct

and guaranteed loans to farmers unable to obtain loans from the Farm

Credit System or other commercial

lenders. All FSA loans provide some

subsidy value or credit enhancement

to the borrower. Interest rates on loans

made directly by FSA are lower than

those on loans from commercial

lenders because FSA rates reflect

lower government borrowing costs

and do not fully account for administrative costs. However, some FSA

loans are made to farmers at interest

rates below the Government’s cost of

borrowing (or below market rates in

the case of commercial loans that are

guaranteed by FSA). These loans, made

through special interest rate assistance

programs, provide an additional

subsidy to targeted borrowers (fig. 1).

Farm credit subsidies redistribute income to low-income farm households

and have found strongest support

during periods of high interest rates

and financial stress. While less costly

methods for the Government to transfer income to targeted populations

often exist, subsidized credit has

nevertheless been used to raise farm

incomes and relieve farm financial

stress. Various low-rate emergency

loan programs have been used since

1918 to help farmers recover from

natural and economic disasters. Low

rates for direct FSA loans were introduced during the 1970’s when market

interest rates were high; low rates for

FSA-guaranteed loans were introduced

during the farm financial stress of

the mid-1980’s.

Originally authorized to stem acute

cash-flow or profitability problems

suffered by farmers, special low-interestrate programs have become permanent

features of Federal farm credit programs. Providing additional credit

subsidies to borrowers may be appropriate when cash-flow problems are

temporary and long-term financial

prospects are good. However, providing subsidized credit merely to

transfer income is costly and unlikely

to be economically efficient. Delivering

such subsidies to needy borrowers,

while excluding such subsidies to

borrowers with adequate access to

financing, is very difficult. The second

group of borrowers, if subsidized,

would reap windfall gains, with no

public benefit to offset program costs.

The U.S. Department ofAgriculture provides

subsidized credit to highrisk farm borrowers unable

to obtain credit from commercial sources. To boost

incomes and to relieve financial stress, Farm Service

Agency programs can

provide additional interest

rate subsidies to borrowers.

However, when market

interest rates are low as in

recent years, these additional

subsidies are less effective in

improving borrower income

and financial performance.

Directing these additional

subsidies to beginning

farmers and socially disadvantaged borrowers or

reserving their use for

more stressful economic

periods may help control

program costs while

increasing benefits to

borrowers and the public.

United States

Department of

Agriculture

Agriculture

Information

Bulletin No. 724-11

February 1998

ISSUES IN AGRICULTURAL AND RURAL FINANCE

When Are Farm Interest

Rate Subsidy Programs

Most Effective?

Direct OL

Guaranteed OL

Direct FO

Guaranteed FO

Emergency

0 300 600 900 1,200

84

530

145

516

1,045

 Source: Economic Research Service compiled from

Farm Service Agency (FSA) data.

Rates:

Fiscal 1997 FSA loan obligation volume

($ million)

Emergency + Direct OL + Direct FO loans.

1

1

Figure 1

Nearly $450 million of FSA's direct farm

loan obligations were made at special low

interest rates

OL = Operating loans. FO = Farm ownership.

Special

Regular/Market
2 Issues in Agricultural and Rural Finance / AIB-724-11 Economic Research Service/USDA

Some FSA Programs

Provide Additional

Interest Rate Subsidies

To provide additional credit subsidies

to low-income farm borrowers, FSA’s

emergency (EM), operating (OL), farm

ownership (FO), and beginning farmer

loan programs offer interest rates below

the cost of government borrowing.

For direct OL and FO loans there is a

limited-resource-rate program; for

guaranteed OL loans, there is an interest rate assistance program (see box).

Special low interest rates for direct

lending programs have been used

extensively. In fiscal 1997, 60 percent

of the $745 million in direct farm loan

obligations (EM plus direct OL and

FO loans) were made at rates below

regular program rates. The percentage

varies through time depending on

interest rate levels, program design,

funding, and the financial condition

of applicants. By law, FSA is required

to lend at least 25 percent of its direct

loans each year at the limited-resource

rate. The use of targeted rates peaked

in fiscal 1981 when market interest

rates and emergency loan authority

were high, and again in the mid-1980’s

as the Government sought to relieve

financial stress through credit programs.

About 14 percent of the $1.6 billion in

guaranteed lending in fiscal 1997 was

made through the interest rate assistance program. Congress intended

that the limited-resource rate and interest rate assistance programs provide

temporary assistance to borrowers

who cannot repay their debt at regular loan rates. Each program requires

that the loan rate be increased to regular rates if the borrower’s financial

condition improves sufficiently.

In contrast to the limited-resource-rate

and interest rate assistance programs,

eligibility for emergency credit and

beginning farm loan program rates

does not depend on ability to pay

regular program rates. In addition to

being unable to obtain commercial

credit, applicants for an EM loan must

have incurred losses from a natural

disaster. Borrowers meeting the definition of a beginning farmer can obtain special low rates even though

they may be able to pay higher rates.

Interest rates charged on these loans

are the same for all applicants and

are fixed for the term of the loan.

FSA Borrower Profile Varies

With Economic Conditions...

Data from USDA’s Farm Costs and

Returns Survey indicate that, compared with similar farms with no FSA

indebtedness, FSA borrowers have

lower incomes and less wealth. In 1995,

about half of direct FSA borrowers

reported debt-to-asset ratios over 0.40,

compared with about one-fourth for

similar farms with no FSA debt.

It is less clear whether limited-resource

rates and interest rate assistance rates

available for OL and FO loans are

directed to the most needy FSA borrowers. Among direct-loan borrowers

at the end of 1995, those paying limitedresource rates had lower net worths

on average than those paying regular

rates, but the difference was not statistically significant. Farm income, offfarm income, assets owned, debt owed,

operator age, and the distribution of

farms by debt-to-asset ratio for direct

OL and FO borrowers paying limited

resource rates were all similar to those

paying regular rates. Yet, analysis of

FSA borrowers during the early 1990’s

showed limited-resource rates to be

serving borrowers who appeared to

have less ability to pay the higher

regular program rates. 

FSA’s difficulty in directing limitedresource rate loans to the most needy

borrowers during the mid-1990’s may

reflect prudent borrower choices. The

early 1990’s was characterized by

generally higher interest rates with the

differential between limited-resource

and regular program rates being much

higher than in the mid-1990’s (fig. 2).

The difference between regular program rates and limited-resource rates

in the direct OL program fell from 3-4

percentage points in fiscal 1991 to as

little as 0.25 percentage points in fiscal

1994. Since regular program rates are

fixed for the life of the loan and limitedresource-rate eligibility is subject to

FSA Loan Rates

Regular Direct Program Rate. Loan interest rates on direct loans (those made,

funded, and serviced by FSA) are set for the life of the loan at the current average

market yield on outstanding U.S. Treasury obligations having maturities of 5 years

for operating loans and 25 years for farm ownership loans, plus 1 percentage point.

Limited-Resource Rate. Direct loan rates set at half the rate on 5-year U.S. Treasury

notes, but not below 5 percent. Eligibility is to be reviewed annually. Limited-resource rates have been at their statutory minimum of 5 percent since 1986 for farm

ownership and since 1990 for operating loans. FSA is required to lend a minimum

of 25 percent of its direct loans at the limited-resource rates.

Guaranteed Program Rates. Loan interest rates on guaranteed loans (those made,

funded, and serviced by commercial lenders, but guaranteed against default up to

95 percent) are negotiated between the borrower and the lender, but FSA regulations

require that the lender charge guarantee borrowers not more than the average rate

charged for similar unguaranteed loans.

Interest Rate Assistance. FSA reduces the rate on guaranteed operating loans by 4

percentage points from the loan rate negotiated between the borrower and the

lender. There is no minimum rate, and eligibility is reviewed annually.

Emergency Disaster Rate. Rate fixed at 3.75 percent for the life of the loan.

Beginning Farmer Downpayment Rate. Qualified beginning farmers are eligible

for 4-percent, 10-year, fixed-rate loans to finance the downpayment on a farm real

estate purchase. Others may be able to obtain 4-percent loans under joint financing

arrangements with commercial lenders.
Economic Research Service/USDA Issues in Agricultural and Rural Finance / AIB-724-11

annual review, many borrowers may

have opted to lock in favorable longterm fixed regular rates rather than

risk a variable rate for marginal interest cost savings. With more limitedresource borrowers choosing regular

rates, the two groups would appear

more alike.

Another possible explanation for the

similarity in FSA regular program and

limited-resource borrowers in 1995 is

that an improving farm economy and

a reduction in the amount of funding

for direct loans have begun to homogenize the two groups of borrowers.

An improving economy and reduced

direct loan funding mean that the most

creditworthy FSA borrowers (who

are more likely to have been paying

regular rates) graduate to other credit

sources. Also, the financial condition

of the borrower may have been poorer

when the limited-resource rate was

approved than when the survey data

were collected.

...As Does Their Impact on

Borrower Finances

The additional subsidies provided

through limited-resource rates or interest rate assistance can affect farm

financial health by lowering expenses

and by lowering the risk profile of the

operator. These subsidies may enable

these farmers to acquire resources, such

as land or equipment, that enhance

their competitiveness, but they benefit

borrowers less as market rates approach

FSA rates. For example, raising the interest rate on all outstanding FSA direct

limited-resource loans in 1995 (when

interest rates were low) to the regular

program rate would have resulted in

an average additional interest cost of

$900 per farm. In the early 1990’s (when

interest rates were higher), such a move

would have resulted in additional interest costs of $2,700 per farm.

The more modest impact on interest

costs of charging higher rates is not

only a consequence of slim interest

rate differentials, but also of less FSA

indebtedness per farm in the mid1990’s. With reduced lending activity

in the 1990’s, FSA has become a less

important source of credit for many

direct borrowers. At the end of 1995,

just over half of the typical FSA borrower’s debt was directly supplied by

the agency, with FSA direct indebtedness averaging just $85,000, compared

with $114,000 in 1991-93. With reduced

indebtedness and low interest rates,

borrowed capital costs are less important in determining financial viability

than during past periods of higher

rates and debt. Total interest expenses

for all debts represented just 12 percent

of total farm cash expense for the

typical FSA borrower in 1995, compared with 15 percent in 1991-93.

Because the interest rate subsidy is

greater and indebtedness higher,

guaranteed FSA borrowers receiving

interest rate assistance are likely to

enjoy greater interest savings and thus

be affected more by any rollback in

program benefits. Yet, total interest

expenses associated with FSA guaranteed indebtedness still account for

less than 7 percent of total farm cash

expenses for the typical guaranteed

program borrower. Therefore, as for the

direct programs, removal of additional

interest rate subsidies has only a modest impact on the financial viability of

these borrowers.

3

Interest rates, fiscal 1977-97 (Percent)

0

4

8

12

16

20

OL regular

OL limited resource

Bank non-real estate

1977 82 80 86 89 92

 Source: Economic Research Service compiled from

Farm Service Agency (FSA) data.

95 97

Figure 2

Although all FSA rates are lower than

commercial rates, the added subsidy value

of FSA's limited resource rates diminishes

as the general level of interest rates falls

OL = Operating loans.

Budget Cost of Interest Rate Subsidies Limits Program Activity

Congress provides a certain amount of money, or budget authority, for FSA lending

programs each year. The budget authority, in turn, supports an amount of lending, or

obligation authority. The amount of lending that a given level of budget authority will

support is determined by the budgetary subsidy rate, or the Government’s cost of

lending $1 under the program. For example, a budget authority of $1 will support $10 of

lending at a 10-percent total subsidy rate, but $20 of lending at a 5-percent subsidy rate.

While regular FSA loan rates are below what a borrower could obtain without a Federal

enhancement, these regular interest rates are not considered subsidized in terms of

Federal expenditures. Providing loans to farmers at interest rates below the government

cost of borrowing is a primary component of the budgetary subsidy rate. Anticipated

loan default costs, repayment rates, and certain transaction costs are other, but more

minor, factors that influence the subsidy rate.

The EM program is the most costly program with a budget subsidy rate of 30.4 percent

for 1997. With a low 3.75-percent fixed rate, the gap between this rate and anticipated

Federal borrowing costs requires a high amount of budget expenditures. Even though

the limited-resource rate is currently 5 percent for both OL and FO loans, the subsidy

rate for a limited-resource FO loan is usually higher than that for an OL loan because

the cost of long-term borrowing is typically greater than the cost of short-term borrowing.

In fiscal 1997, the subsidy rate for the farm ownership program was 21 percent as opposed

to 12.6 percent for the operating loan program.

The budget subsidy rate for guaranteed operating loans was just 1.1 percent for fiscal

1997. Each dollar of guaranteed operating loan budget authority supported $91 in

lending authority during the year. However, when the 4-percentage-point interest rate

assistance is provided, the budget subsidy rate for a guaranteed operating loan rises to

9.1 percent and allows just $11 in lending authority for each dollar of budget authority. 
4 Issues in Agricultural and Rural Finance / AIB-724-11 Economic Research Service/USDA

For FSA borrowers with low household incomes, the annual savings

through additional interest rate subsidies can be much more consequential. However, if the policy objective

of an interest rate subsidy program is

to redistribute income, other methods

(grants, for example) may be more

cost effective and have greater impact

on borrower income levels. Forty-five

percent of all limited-resource borrowers were near or below the poverty

level and 33 percent of all guaranteed

borrowers were near or below the

poverty level in 1995. In the low-interest-rate environment prevailing in

1995, removing the additional interest

subsidy for limited-resource borrowers

would not have a substantial impact

on the percentage of borrowers below

the poverty rate. In fact, eliminating

all FSA interest expenses for guaranteed borrowers would still leave 30

percent of these borrowers near or

below the poverty rate.

If FSA loan demand is high, maintaining additional interest rate subsidies

means that some FSA-eligible borrowers cannot be served. This occurs because Congress grants a fixed amount

of money (budget authority) each year

to make FSA loans, and loans made

under interest rate subsidy programs

require more budget authority per

dollar loaned (see box, p. 3). Therefore,

for each dollar in authorized spending,

there is a tradeoff between the number

of borrowers served and the level of

assistance individuals receive.

Conclusions

Limited-resource interest rate subsidy

programs are more effective in assisting

the lowest income FSA borrowers when

prevailing interest rates are high.

Financial profiles of direct program

borrowers paying regular FSA rates

and those receiving additional interest

rate subsidies were very similar in

1995. However, in the higher interest

rate environment of the early 1990’s,

financial profiles of the two groups

were more dissimilar. This result is

consistent with the longer term interests of borrowers because their interest rate risk is greater in programs

that offer temporary additional interest

rate subsidies. When market interest

rates are low, subsidies to reduce interest rates further have less impact

on borrower income and financial

performance than when market interest rates are high.

To improve effectiveness of program

delivery, FSA interest rate subsidy programs could be more narrowly targeted to the most financially stressed

farms, including beginning or socially

disadvantaged farmers. Alternatively,

the limited-resource-rate program

and all other low interest rates could

be reserved for use only during more

stressful economic periods, and eligibility for these interest rate subsidies

could be removed on a more timely

basis. Also, requirements that a set

percentage of FSA loans be made at

limited-resource rates could be removed; under low interest rate conditions, borrowers are often better served

by paying regular program rates that

are not subject to an annual review.

Contacting the Author

Steven R. Koenig

(202) 694-5353 (voice)

Charles B. Dodson 

(202) 694-5345 (voice)

(202) 694-5663 (fax)

e-mail: SKOENIG@ECON.AG.GOV

CDODSON@ECON.AG.GOV

Further Readings

Bosworth, B.P., A.S. Carron, and

E.H. Rhyne. The Economics of Federal

Credit Programs. Washington, DC:

The Brookings Institution. 1987.

Collender, Robert. Can Federal Action

Improve Efficiency in the Market for Farm

Loans? AIB No. 724-01. Mar. 1996.

Dodson, Charles B., and Steven R.

Koenig. “The Farm Service Agency’s

Limited Resource Interest Rate

Program in the 1990s.” Agricultural

Income and Finance, Situation and

Outlook Report, AIS-64. Feb. 1997.

Finding Reports in This Series

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through the ERS AutoFAX. To use

the AutoFAX, call (202) 694-5700 on

your fax machine’s handset. Enter

41100 for a directory of available reports. This document is no. 41111.

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