With a self-managed super fund, you can buy either a commercial or residential property, helping you to grow your super fund for your retirement. Find out everything you need to know about SMSF loans, how they work, and who can benefit the most from SMSF borrowing.
What Are SMSF Loans?
When you have an SMSF, you are in full control of your super. You and the other members of your self-managed super fund, if there are any, decide how to invest the money in superannuation. This is opposed to having financial professionals choose how best to invest the money when you contribute to a managed super fund.
You’ll decide what investments to use to grow your retirement nest egg and it’s up to you to research investments to help optimise your super savings. Having a self-managed super fund isn’t for everyone. For those who have experience or enough investment knowledge, however, an SMSF can offer certain advantages like tax benefits and more flexibility over retirement investments.
If you want to invest in property, you can use the SMSF to buy real estate. You can use money in the super cash account as a deposit for your loan and then take out a loan in the name of the SMSF for the remaining balance. SMSF loans are similar to trust loans – in fact, an SMSF is a type of trust. They are more complex than standard property investment loans but they can offer advantages to the trustees, making them a worthwhile option for some borrowers.
There are, however, a lot of rules and considerations when it comes to SMSF borrowing. You’ll want to do your financial homework to make sure you’re always making the best choices for your financial future. It’s also a good idea to consult with your financial advisor to make sure you understand the risks and benefits that apply to you.
Navigating the process of qualifying for an SMSF loan can be tricky because there are so many factors involved. Call us on (07) 3146 5732 or contact us here any time to talk to one of our mortgage brokers who specialise in borrowing through self-managed super funds.
What Are the Rules for Buying a Property Through an SMSF?
If you and the other trustees of the fund (there can be up to four) have decided buying real estate with your SMSF is a worthwhile strategy, you’ll need to make sure your property meets certain requirements. Here are the SMSF rules set by the government:
- The property can’t be rented by anyone who’s related to you or any of the other fund members. You can’t, for example, purchase a property with an SMSF and rent it to your child.
- No one who is related to any of the fund members, nor any of the trustees themselves, can live in the property. If you’re planning on living in your investment property when you retire, even part-time, you might not be able to purchase the property with an SMSF loan.
- One of the trustees of the SMSF can’t be the one to sell the property to the other members. Nor can any relatives be involved. There is some exception for commercial property but make sure you speak with an accountant with experience with SMSFs to avoid any hefty tax penalties.
- And finally, the property must be intended for the sole purpose of providing retirement benefits for the trustees of the SMSF.
Essentially, SMSF borrowing is available for property investing to benefit your retirement only. You can purchase either a residential or commercial property that will never be lived in or occupied for business by anyone in the trust or any relatives.
Are There any Lender SMSF Loan Restrictions?
In addition to the government restrictions, there are other limits set by lenders.
- Refinancing an existing SMSF loan isn’t an option with the majority of lenders. Contact us and we can let you know about the lenders we work with that are offering SMSF refinances.
- You can pay for renovations with the funds in your SMSF but you can’t borrow money for renovations or take out a construction loan.
- You’ll have to meet your lender’s liquidity requirements to qualify for an SMSF loan. Basically, you have to have a set value in your cash account rather than tying up all of your super fund with equity shares and other investments.
How Much Can You Borrow with an SMSF Loan?
Where you can often borrow 90% of the Loan to Value Ratio (LVR) or more with a standard residential investment loan, with SMSF loans, you won’t be able to get a high LVR loan. Often, this isn’t an issue as borrowers who use their SMSF already have a significant amount saved in superannuation, which can be used for the deposit. But, it’s something to keep in mind as you’ll have to devote enough of your super fund cash to cover at least 20% as well as the loan transaction costs.
This is superannuation money you won’t have to direct towards other investments. The high deposit requirement is one reason it’s important to talk with your financial advisor about your overall retirement investment strategy before applying for an SMSF loan.
With SMSF loans, expect to:
- Borrow up to 75% to 80% of the property value for a residential property.
- For a commercial property, you may be able to borrow up to 70% LVR at the most.
- For low doc SMSF loans, bad credit loans, or other specialised borrowing, lenders will expect your deposit to cover an even greater percentage of the purchase price. You’ll also have fewer lenders to choose from.
Keep in mind, some lenders – especially those who are more well-known for SMSF lending – tend to have more flexible lending policies. Please call us on (07) 3146 5732 to talk to an SMSF mortgage specialist to find out more, or contact us online.
What Income Sources Will Lenders Consider?
When you take out an SMSF loan, it’s the income that the trust earns that the bank will primarily look at. Lenders want to know there is enough money coming in from the SMSF to service the loan, rather than looking at your work income like they would if you were applying for the mortgage yourself.
What income verification do you need to provide for an SMSF loan?
Lenders will want to see the last two years of tax returns for the SMSF. They may assess the fund’s investment income plus the predicted rental income from your property.
What if your super’s income isn’t high enough?
There are lenders that will also consider your personal income, as well as the income of other members of the fund or beneficiaries as long as there is a personal guarantee.
What Fees Are Involved with SMSF Home Loans?
There are a number of fees you’ll have to pay both to maintain your SMSF and to buy a property with your fund. It’s important to look carefully at these fees, especially if you don’t have an SMSF yet but are thinking of using one specifically for property investment.
Just to operate your self-managed super fund, you’ll need to pay:
- Set-up fees
- Ongoing costs such as an annual audit fee and the ATO supervisory levy
- Transaction costs
When purchasing a property with your SMSF, you’ll also have to pay:
- Legal fees
- Cost of financial advice
- Loan application fees
- Stamp duty
- Ongoing bank fees
Don’t forget to also account for property management fees for your rental.
Your SMSF operating costs combined with your ongoing SMSF loan fees and property management expenses can add up to several thousand dollars a year. Borrowing through your SMSF may still be advantageous but it’s a good idea to look at all the numbers so you understand just how beneficial it will be.
Not only are there fees involved, but also, running your super fund will take time in itself. For those with sizable super funds and investment knowledge, SMSF loans are often ideal. If you aren’t certain about what’s involved, including all the costs, talk to your financial advisor or accountant to help you weigh the costs against the benefits for your unique situation.
What Are the Limits of SMSF Borrowing?
In addition to the costs of SMSF loans, there are some restrictions and risks you’ll want to keep in mind:
- You can’t alter the property if it would change the character of the building until after the loan is paid off.
- Because the loan repayments are made directly from your SMSF to your lender, you always have to have enough liquid assets in the fund. This can limit your decision making, especially when you retire and may want to use some of the income from your super for your lifestyle expenses or other investments. Until the property is paid off, there has to be an adequate cash flow.
- You can’t offset your tax losses from the property against your taxable income.
Can the Bank Go After Other Fund Assets if You Default?
No, SMSF loans are limited recourse loans. This means, if there isn’t enough in the SMSF to make the mortgage repayments, including contributions from the fund members, and the loan goes into a default, the bank doesn’t have any claim on the other assets in the super fund. They are limited to the property the loan is for.
This is also one of the reasons why lenders are often strict with SMSF loans and won’t offer high LVR loans – they won’t get anything back in the case of a default beyond what they get from selling the property. The 20% or 30% deposit is intended to buffer any losses they could see if they have to sell the property to recoup their costs.
It’s also why lenders will want to know the property will be easy to resell in the case of a default. For example, with SMSF loans, bank are more comfortable lending when the property is in a major metro area where it’s easy to find a buyer.
What Are the Benefits of SMSF Borrowing?
Even with a lot of restrictions, costs, and rules, there are benefits that can make purchasing real estate through your SMSF worthwhile.
- Asset protection: Because SMSF loans have limited recourse, you don’t have to worry about the bank going after the assets in your fund in the case of a default.
- Tax savings: You may be able to lower your SMSF’s tax liability by claiming the loan interest on your SMSF’s tax returns.
- Wealth building: SMSF borrowing allows the fund to potentially increase its assets tremendously with real estate, gaining in both capital growth and investment income. It also may give property investors the ability to invest in more real estate that they otherwise couldn’t purchase outside of the super because they don’t have enough personal income to service another mortgage.
- May not have to save for the deposit: As you can use the funds in your super as a deposit, you don’t have to save up for a large downpayment. You can even move money from a managed fund to your self-managed super fund to buy a property.
- May not have to use personal income to make repayments: As SMSF loans are paid back with the rental income, if you've invested in a property that should bring in a healthy return after property management, insurance, and other expenses are accounted for, you won’t need to use your income or other resources outside of your SMSF to meet the mortgage payments.
- High investment potential: It is possible to buy a property that’s worth more than your SMSF through gearing benefits.
How SMSF Loans Work
With an SMSF loan, the lender loans the borrowed amount to the SMSF, not you or one of the other trustees. Repayments are made just like they would be with a traditional investment loan. However, the money comes from the SMSF every month, not your bank account.
The SMSF is also the entity that receives the payment from your property’s tenant. The trust (you and the other fund members) will handle the lease and make sure everything is set up with your property manager but the tenant pays the SMSF directly.
For example, if you wanted to purchase real estate valued at $400k, you may be able to get a loan for 75% of the LVR, which would be $300k. You would then need $100k plus money for stamp duty, conveyancer fees, and other expenses, as liquid cash in your super fund. The bank would then take the deposit and the transaction costs from the SMSF.
Then, as the trustee, you’d arrange for the lease. The rental payments, your employer's super contributions, and other income from your SMSF would be used to make the loan repayments. You and the other members of the trust would also be able to contribute to the fund to ensure there was always enough in the cash account to cover loan instalments.
Once the trust pays off the loan, the bank transfers legal ownership to the SMSF.
A Look at the SMSF Loan Structure
SMSF loans are structured differently than other property investment loans. A lot of the nuances of SMSF borrowing stem from the fact that they are limited recourse loans.
In fact, a lot of lenders will request personal guarantees to reduce the risk of lending with limited recourse, which means they would be able to go after personal income and assets in the case of a default. With 60% LVR loans and higher, the bank may ask for a personal guarantee from all members and SMSF beneficiaries.
There also has to be a separate arrangement, known as a bare trust or custodian, to house the asset until the loan is paid off and ownership for the property is turned over to the SMSF. The bare trust separates the other super assets and serves as the security for the loan.
Here’s a general look at the SMSF loan structure:
- The lender loans the balance after the deposit to the SMSF.
- A bare trust is set up to purchase the property on behalf of the SMSF.
- This trustee of the bare trust is considered to be the legal owner of the property until the loan is paid off.
- If there are no personal guarantees, the lender only has a right to the asset in the case of a mortgage default, which is held by the bare trust. If there are personal guarantees, the lender could also seek to recoup their losses by going after personal income and personal assets.
How Hard Is It to Qualify for an SMSF Loan?
The reality is, a lot of lenders don’t offer SMSF loans, including some of the major banks. Lending to super funds involves more work on their part because of the complex nature of trust loans. Also, as the loans are limited recourse, lenders only have the asset to use to try and recover their losses if there is a default. This opens them up to more risk unless they ask for personal guarantees.
There are, however, other lenders who actively seek out this market. Some will even offer discounts to super funds and it is possible to get a competitive interest rate. Everything depends on the lender you apply with and which lenders you are likely to qualify with.
Our mortgage brokers are aware of the most competitive SMSF lenders. Contact us today and we can talk to you about the different lenders and SMSF loan packages available on the market right now.
How Do Lenders Assess Super Contributions When Looking at SMSF Loan Serviceability?
When looking at the income of your SMSF, lenders will consider your super contributions as long as you are still working and have a personal income. This makes it easier to qualify for a loan with your SMSF rather than if everything hinged on your expected rental payments.
Lenders won’t, however, calculate 100% of your super contributions. Rather, they’ll look at a percentage of it. For example, they may assess the required employer super contribution – which is currently 9.5% of your ordinary earnings – and take 80% of that figure.
What if you’re already retired or are going to retire in a few years?
If you are close to retirement age, your lender may decide not to factor in your super contributions at all, knowing they’ll cease in the next few years anyway. You may have to apply for a smaller loan, which means you’ll need a larger deposit if you want to purchase the same property or you'll be more limited in the real estate you can purchase through your SMSF. Or, depending on your situation, the lender many simply shorten the term of the loan.
What about your investment income from shares and other assets – can this income help to verify the loan’s serviceability?
It depends on the lender. Some will look at other investments but not all will because there’s no guarantee that you’ll hold on to these investments or that the investments themselves won’t change in value – which means they can’t predict your investment income accurately. Also, keep in mind, if you are selling your fund’s assets to use as the loan deposit, you won’t earn an income from them any longer.
If you want to learn more about which banks will look at other forms of income, fill out our online contact form today or call us on (07) 3146 5732.
Ready to Set Up a Self-Managed Super Fund?
If you don’t already have a self-managed super fund, run through this checklist to make sure setting one up may be right for you. It’s also important to discuss your options with an independent financial advisor.
Is your fund balance large enough to dwarf your SMSF operating costs? When you contribute to a standard retail fund, you’ll usually pay around 1% to 2% of the value of the fund in fees every year. Compare this to what you’d pay with an SMSF. Look at the ATO supervisory levy, the Annual ASIC Corporate Fee, trading fees, and accounting and audit fees, as well as any financial advisory fees for services you may use.
Will you miss out on your employer-provided super fund benefits? What benefits do you have now through your managed super fund? Benefits like cheaper life insurance you’ll have to set up yourself.
How is your investment knowledge? Managing your fund yourself does require time and effort on your part. Also, the performance of your fund falls solely on your shoulders – there is no way to receive compensation for lost funds like you can with other funds. Ideally, you have some personal investment experience, you have time to research the investment markets, and you stay up-to-date with all regulation and taxation changes or, at least, regularly speak to an experienced financial professional to help you with any advice and requirements you need to keep up with.
Managing Your Super Fund
Once you have your SMSF set up, you’ll manage it based on the rules set up in the trust deed and the general rules for self-managed super funds. There are quite a few rules, some of which change over time, but here are some of the basic ones for managing SMSF.
- Contributions: You and other members can make contributions in addition to your employer super contributions. In order to avoid penalties, stay within yearly contribution caps for your age.
- Tax reporting: You’ll have to file a tax return for the SMSF every year and keep accurate records of transactions, earnings, and anything else that goes on within your fund. Unless you have a lot of accounting experience and the time, you can have your accountant help you with the administrative work. Generally, the tax rate for super income is 15% although there are instances where it can be higher.
- Managing investments: When it comes to managing your investments, you can’t mix your superannuation assets with your personal or business affairs. Super fund investments are only for the benefit of building wealth for your and other fund members’ retirement.
When Can You Access Your Super Fund?
There are cases where you can access your super fund before retirement but only when you are facing financial hardship. Otherwise, you’ll have to wait until your preservation age, which is between 55 and 60 years of age, depending on when year you were born.
If you reach your preservation age but aren’t retired yet, you’ll be able to access part of your super. Once you are fully retired or reach 65, you will be able to fully access your super fund savings.
This lack of accessibility before retirement is part of the reason being able to invest in real estate with a self-managed super fund is so appealing to a lot of Australians, especially older individuals who want to take more control of their wealth and are interested in getting into the property market. You may not be able to take out your super savings to buy property, but with an SMSF, you can use your fund to purchase a rental property.
Real estate is known for being a more stable investment than shares and a more lucrative investment than the bond markets. With an SMSF loan, it’s possible to add a rental property to your assets without having to save up for a large deposit outside of your retirement savings. Nor do you have to worry about a lender determining that you can’t service an investment loan because you may be still paying off your home mortgage, you’re too close to retirement, or you may have an outstanding balance on a different investment loan.
How to Get the Most Out of Your SMSF Loan
In order to get the most out of purchasing real estate with an SMSF loan, the key is to walk into every decision with as much knowledge as possible. This is why you’ll usually benefit from consulting with and using the services of financial professionals.
There are a lot of details of SMSF borrowing that can cost you or save you a lot of money. The more you know, the more you may be able to reduce risk and get the right loan for you.
For example, with some lenders, you’ll have to pay stamp duty twice. When you use a lender’s security custodian (which some lenders require) to hold the property in a trust until the loan is paid off, you could end up being charged stamp duty a second time – first on the property purchase and later when the property is transferred from the holding trust to the self-managed super fund.
You could also end up paying fines if you don’t comply with all the ATO and government regulations.
With the help of an accountant and financial advisor – who have specific knowledge in SMSF lending – it will be a lot easier to avoid extra fees and to stay compliant.
Applying for an SMSF Loan
More Australians are turning to SMSFs and are taking advantage of SMSF loans to buy a rental property. According to ATO data, from 2012 to 2017 SMSF lending-based property assets in relation to other assets jumped from 3.51% to 21.17%. There was also a 25% increase in self-managed super funds over the same period.
If you are thinking of applying for an SMSF loan, be sure to talk to your advisor and accountant about your investment strategy and tax and administrative requirements. As mortgage brokers with experience with SMSF loans, we can help you find a loan that works for you.
There is a sizable discrepancy in fees and interest rates for SMSF loans so you want to make sure you know about the most competitive loans available that you can qualify for. You also want to get the right features, like a 100% offset account, which can help you save a lot of money in interest if you have a high balance in your super’s cash account, making it easier to pay down your loan faster.
Our SMSF loan specialists can offer insight and guidance into the loan application process. Call us on (07) 3146 5732 to talk to one of our experienced mortgage brokers today or fill out our online contact form here to get started.