Self Managed Super Fund Loan Structure (SMSF Loan structure)
Most people have heard of self managed super funds (SMSF’s) and many people are aware that SMSF’s can borrow money to purchase property. There is still considerable confusion around how this works and if indeed it’s worth the complexity. In this blog post I will outline the basics of SMSF lending, the mechanics of how these borrowing arrangements are set up as well as some of the pros and cons with this investment strategy.
I will be focussing purely on borrowing to purchase residential investment property as opposed to commercial property which has some additional complexities. Also please seek your own qualified advice re the tax and legal position of borrowing within your superannuation. I am neither a lawyer, an accountant or a financial planner so the information here should not be relied upon as advice.
So first things first what exactly is a Self Managed Super Fund (SMSF)?
A SMSF is a trust set up to hold and manage superannuation funds and investments for up to four individual members with the typical set up being two members, a husband and wife). A trustee is required to be appointed to manage the fund and they choose the asset allocation of the investments and manage the compliance responsibilities. The trustee can be either a company, the directors of which have to be the same as the members or the actual individuals themselves can act as the trustees. The trust structure is set up to quarantine to SMSF’s assets both from the members themselves (until retirement) and potential creditors of the individuals
SMSF’s and limited recourse loans:
SMSF trusts can borrow money to assist them to purchase investment properties but only if the loan granted to the trust is non-recourse against the super fund’s other assets. The property being purchased can be sold by the lender to recoup the loan funds (in the case of a serious loan default) under their powers as mortgagee but they cannot go after the SMSF’s other assets.
Are personal guarantees required?
Lenders have been a bit slow to embrace SMSF lending. This is part due to the fact that under these arrangements they have their security position diluted by the limited recourse nature of the loans. This has meant that for them to be comfortable LVR’s are limited to not more than 80% and guarantees from the members of the fund are generally required in one way or another. This means the lender can then go after the members other personal assets and income to recover their loan funds in a worst case scenario. If the LVR is low enough (circa 50%) personal or bare trust director’s guarantees can sometimes be waived.
The SMSF loan structure:
Which name do I set things up in?
• Contract for sale, mortgage and title deed name = bare trust trustee
• Borrower = SMSF trustee
• Personal guarantors = usually all members / beneficiaries of the SMSF itself.
• Director guarantees = usually all directors of the bare trustee company and SMSF trustee company will be required to give guarantees.
Paying the SMSF loan & loan affordability:
For the loan to be acceptable to the lender in terms of affordability and without taking into account personal incomes the loan repayments must be met from a combination of rental income, compulsory super contributions (9.25% of salary at time of writing) and the funds other regular income if applicable. Note: lots of variations to lenders policies here but for illustration purposes here is an example.
Example of lenders SMSF serviceability calculation:
$500,000 property purchase price and $400,000 loan required (80% LVR).
- Benchmark interest rate used for calculation of affordability by the lender is 7.5% pa.
- 30 year term loan sought.
- Market rent is $1950 / month.
- Members’ annual salaries of $100,000 and $65,000 gross.
- Employer super contributions at 9.25% of salaries.
- Other income generated from the SMSF such as interest and dividends from funds not being utilised for the property deposit = $5000 pa.
Lender takes the following amounts per month for affordability calculations:
- Rent @ 80% of amount paid by tenants = $1560
- 80% of employer super @ 9.25% of gross salary = $1017
- 80% of other SMSF income = $333
(Total assessable income = $2910) - ($400,000 loan @ 7.5% pa over 30 years = $2797) = $113 / month surplus = loan amount is acceptable.
The pros and cons of SMSF property lending / investment (as I see it!)
- Gearing existing super funds can super size your funds investment returns (capital growth).
- Capital gains tax exempt if sold after 60 years old.
- For property investors can mean more investment property purchases are possible if serviceability is restricted outside of super.
- Invest in direct property rather than equities or other investments.
- Stable returns i.e. rent.
- Considered a fixed trust asset so acquires the NSW land tax threshold.(seek advice).
- Non diversified investment as most peoples other major asset is their own house. Could be all eggs in the one basket i.e. residential property.
- Can't re-borrow against the property to utilise equity gained for further investing like can be done with property outside of super.
- High set up and maintenance cost of SMSF.
- Slightly higher %'s.
- Legislative risk in change to rules.
- Mortgage duty would be payable if the borrowing entity is a Pty Ltd company.
- General complexity.
Are you interested in getting a loan to buy property via a SMSF ? if so please contact me to discuss in detail. Thanks for reading, Marty McDonald
1300 711 054 / contact me