Money Mentor: making the most of unexpected income

Question: I’ve recently inherited some money unexpectedly and I’m trying to figure out the smartest way to use it. I have plenty of outgoings – a mortgage on my home with about 18 years left, as well as various farm borrowings, including some hire purchase agreements on machinery that have pretty high annual repayments.

These hire purchase payments are really squeezing my monthly cash flow.

Should I use the money to pay down my mortgage or tackle the farm debt first? I want to make the right choice for my family’s long-term financial security, while also keeping the farm business healthy.

Answer: When unexpected money comes our way, it’s crucial to take a strategic approach instead of just making quick decisions. Let’s break down your options and consider what might work best for your situation.

Firstly, let’s understand why this decision requires careful thought. The mortgage represents personal security and typically has a lower interest rate, but runs for a longer term. Farm borrowings, especially hire purchase agreements, usually have higher interest rates and can create significant pressure on monthly cash flow due to their shorter repayment terms.

So, how do you decide what to do? We recommend approaching the decision systematically.

First of all, compare your interest rates. Before making any decisions, list out all your debts and their corresponding interest rates. Typically, the hierarchy looks something like this:

- Hire purchase/leasing: 8-12% APR

- Farm business loans: 5-8% APR

- Mortgage: 4-6% APR

1. Assess your cash flow impact: High monthly hire purchase payments can create significant stress on farm cash flow, potentially forcing you to make poor business decisions or rely on merchant credit during tight periods. Consider how much breathing room you’d create by reducing or eliminating these payments.

2. Think about tax implications: Remember that interest on farm borrowings can typically be written off against your tax bill, while mortgage interest usually can’t be (unless part of your home is used for business). This effectively reduces the real cost of farm borrowings compared to personal debt.

3. Consider your life stage: Your age and stage in farming are relevant factors. If you’re in your prime farming years with plans to expand or develop the business, maintaining good cash flow might be more important than reducing your mortgage.

It pays to be strategic

Based on the considerations we’ve just gone through, here’s a recommended strategy.

Target high-cost debt first, so if your hire purchase or lease agreements carry significantly higher interest rates than your mortgage (which they likely do), prioritise paying these down first. This approach usually makes the most financial sense because:

• It eliminates your highest-cost debt

• It frees up monthly cash flow, giving you more financial flexibility

• It reduces the total interest you’ll pay over time

• It strengthens your business’s financial position

It’s always best to illustrate with an example, so let’s suppose you have these existing borrowings (see table below for further details).

Paying off the two hire purchase loans:

• Saves over €5,000 per year in interest

• Frees up €32,000 in annual cash flow

• Gives you more flexibility in your business decisions.

Building financial resilience

Once you’ve addressed high-cost debt, consider creating a financial buffer before making extra mortgage payments. Having some financial reserves can help you:

• Take advantage of bulk purchase discounts

• Avoid future high-cost borrowing

• Handle unexpected expenses without stress

• Invest in opportunities

While personal circumstances vary, in most cases, the optimal strategy would be to:

1. Clear high-interest HP/leasing agreements first.

2. Maintain a reasonable cash reserve for business flexibility.

3. Consider partial mortgage overpayments with any remaining funds.

Remember that this doesn’t have to be an all-or-nothing decision.

You might choose to split the money, using most of it to clear high-cost debt, while making a smaller mortgage overpayment or creating an emergency fund.

Noreen Lacey is head of banking at ifac, which is the professional services firm for farming, food and agri businesses.