Hobby Farm Financing
A hobby farm can have different definitions. But the basic idea is that a hobby farm is a
small-scale farm that is primarily for pleasure instead of being a business venture. The owner or owners of a hobby farm typically have a main source of income, like an off-farm job, a pension or retirement income, or perhaps a trust fund. Whatever the source, the point is that the farm does not have to make money — it can be engaged in on a hobby level.
So if one season’s yield isn’t favorable, it is considered more of a disappointment rather than a financial loss.
Hobby farmers may have a lot of money to invest in their farming endeavors, or they may only have a little and be operating on a shoestring budget. But compared to homesteaders, hobby farmers typically aren’t driven by the primary goal of self-sufficiency.
They may be very content to continue their jobs and farm on the weekends or to use their retirement income to invest lavishly in the farm animals they choose to keep. The farm may add value to their homes, so minimal upkeep is all they need to retain that value.
With hobby farming, there can be some overlap with homesteaders; it’s really a spectrum. A hobby farmer may want to be able to maintain the farm with just a part-time job so that she can spend most of her hours farming. She may also want to have a small budget for investing in farm implements, animals, and infrastructure.
In this case, it really depends on how the individual farmer identifies. There’s a blending of motives and means where a hobby farmer is not very far from a homesteader at times.
The choice to run a hobby farm is really all about what you feel fits your goals best and describes what you’re doing accurately. There are no hard-and-fast rules as to what constitutes a farm, so hobby farmers have a lot of wiggle room.
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Launching A Hobby Farm
There is something important to know about launching a hobby farm. The U.S. Internal Revenue Service disqualifies hobby farms from receiving tax breaks earmarked for small-farm owners. Some people have claimed hobby farms as tax shelters by people looking to avoid paying taxes on pastoral spreads, horse shelters, and ranches that they maintain for enjoyment.
Section 183 of the U.S. tax code explains the details of tax allowances for hobby farms. Small farms that are in business should be prepared to prove their business operations and income as not to miss out on being designated as a hobby farm and therefore missing out on tax benefits.
There are financing challenges to overcome on this type of property, which straddles the line between residential home and commercial enterprise. Secondary market residential investors such as Fannie Mae and Freddie Mac will generally reject rural properties with agricultural characteristics.
Brokers interested in originating loans on these properties will need to seek out lenders that offer affordable, 15- or 30-year fixed-rate products. In addition, to underwrite these loans, originators will need to ask hobby-farm clients for documentation relative to their business to account for their self-employed, hobby-farm income. This documentation should include detailed projected income, expense reports and perhaps even business plans.
Regulations
Depending on the lending and risk philosophies, many lenders choose to follow Qualified Mortgage (QM) ability-to-repay (ATR) regulations for rural home loans with hobby-farm characteristics. For brokers seeking to finance these properties, the key will be ensuring their clients have a debt-to income (DTI) ratio no higher than 43 percent.
Although many lenders establish their guidelines at the standard 36 percent DTI-ratio threshold, they often will approve ratios as high as 43 percent with compensating factors.
Factors that can warrant raising the DTI ratio include strong net worth, high cash reserves and credit histories that demonstrate the ability to handle debt. The DTI ratio is calculated by dividing borrowers’ total monthly debt obligations by their total monthly income, including revenues from the property itself. This is where documentation showing hobby farm income becomes critically important.
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Underwriting
As far as underwriting is concerned, brokers and lenders need to understand the unique characteristics of properties that comprise rural America. Finding appraisers that specialize in hobby farms will be difficult, but lenders with experience financing rural properties should have a network of quality appraisers available to them.
The main issue, however, is that hobby farms don’t fall into any sort of typical property that most appraisers deal with.
The country is full of appraisers that can appraise residential properties in cities or even rural homes with 10 acres or less, because it is much easier to find comparable sales in local market areas for these properties. You also can find appraisers that specialize in larger acreage/commercial type of properties, although these often have large appraisal fees attached to them.
Hobby Farm Challenges
Hobby farms come in all shapes and sizes, however, so lenders must possess the flexibility and acceptance of appraisals on this type of property. Finding even one comparable sale that has most of the same characteristics as a hobby-farm property can be a challenge.
Appraisers must be able to widen the diameter of distances of the comparable sales to the subject property. They also may need to increase the number of properties used in their comparable sales analysis and perhaps even use a property that is currently listed.
Beyond the loan closing, owning a hobby farm could result in costlier general property upkeep, not only to the home but also to the outbuildings on the property. Lawn care, landscaping, snow removal — in some parts of the country — and expenses related to hobby-farm activities also will have an impact on the ownership of the properties.
These are issues that commercial mortgage brokers often can help their clients deal with, but may be new territory for both residential brokers and their new, hobby-farm-owning clients. Being able to help clients deal with these types of issues often will win you a client for life.
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Hobby Farming Federal Grants
There are a few federal grants issued to hobby farms if the property qualifies. Grants.gov is a great place to start you research. Also, the USDA Alternative Farming Systems Information Center lists resources and opportunities for grants and loans for small farmers and other agricultural producers.
Another place to check for grant opportunities is your Cooperative Extension office. There you can find local and individual assistance for your particular situation. Your Cooperative Extension Office can be a helpful source of information and save you a lot of time spent hunting through grant listings that make no sense for your needs or location.
The Sustainable Agriculture Research and Education organization and
beginningfarmers.org are also great resources with lists of possible grants, state programs and links to private lenders.
For many, the benefits that come from owning rural property will far outweigh any challenges faced in financing, underwriting or post-purchase expenses. Creativity in hobby-farm business concepts is prevalent all over the country. For brokers up to the challenge, the opportunities presented by this niche can be worth the effort. For the new owners, pride of ownership, a sense of accomplishment and the ability to enhance the rural landscape all contribute greatly to the upgraded
American dream.
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