SMSFs have enjoyed the ability to borrow to buy residential and commercial property since 2007. Its been an extremely popular strategy for mum and dad investors and “millennials” looking to increase their exposure to property with the booming property market in major capital cities. However, due to the Royal Commission and possible change of Federal Government where the Shorten led Labor party is promising to ban SMSF Loans, SMSF lenders are shrinking everyday, reducing the overall competitiveness of the market.
What is a LRBA?
In 2007, s67A of the Superannuation Industry (Supervision) Act 1993 (SISA) was introduced to allow borrowing to buy property. The LRBA or SMSF loan would be different to any other investment loan as they are “limited recourse” not full recourse – with the rights of the lender in the event of default limited to the asset held under the LRBA. This is not the case for other loans which are full recourse. As a result, SMSF loans are generally more onerous, and has a higher interest rate – for example market lenders offer a investment loan at around 4% comparison rate whereas SMSF Loans will start at 6% with a large application fee and legal fees of up to $3000. In addition, there are costs involved with financial advice and setting up the LRBA.
What is a Related Party Loan?
A related party loan is where the SMSF borrows money off a related party of the fund instead of a SMSF lender. This may be from personal savings of a member(s) or off the equity of the members of the fund.
How does a related party loan work?
I personally am a fan of related party loans and hold these myself. If a lender is not feasible for you – based on rate or product (SMSF residential loans are generally 6% plus fees), you may consider a related party loan. It is important to seek advice prior to entering into a related party loan agreement, however you have the ability to borrow against non-super assets or your personal home (i.e. equity) and on-lend to the SMSF.
PCG 2016/5 was released by the ATO detailing the requirements of the loan to be compliant with Superannuation Law.
For example, SMSF is planning to buy a property for $500,000. borrowing 70% of the purchase price of the property. The fund intends to borrow off a member for the reason that they either do not satisfy the SMSF lenders criteria or a prefer to borrow off myself for flexibility and cost (i.e. massive savings in application, legal and monthly loan fees).
Prior to settlement, the SMSF will require a loan of $350,000 from either the members funds (i.e. cash on hand) or equity in property (i.e. offset). In addition to the deposit on the property being paid from the super fund, the loan will be made to the SMSF. The maximum LVR will be 70% or $350,000. The remainder of funds will be sourced from the current SMSF liquid assets. The following will need to apply:
- Loan agreement to be drafted detailing the loan to be signed and executed by all parties
- Interest rate of 5.85% Principle and Interest to apply to be paid monthly from the SMSF to the lender
- The interest rate can be fixed or variable
- The loan term should be a maximum of 15 years
- A Registered mortgage over the property is required
The above will apply to both residential and commercial property
In this example, say you are paying a home loan off at 4% comparison rate, and the SMSF is paying the member 5.85% P & I, the SMSF will pay interest from the SMSF to you or your offset account. This actually exceeds the payment you are making on your 4% comparison rate on your home loan. This is a clear example of the benefits of a related party loan as opposed to a SMSF loan from a bank. There is no hefty application fee, no legal fees which is a saving in establishment fees of up to $5000. Further, many lenders charge a monthly fee – which adds up over the period of the loan.
For those uncertain about the future of SMSF loans, it may be prudent to consider your ability to use a related party loan, particularly in the event SMSF Loans are removed or banks stop offering SMSF loans altogether. This will certainly, take the power away from the lenders (to an extent) and enable you to provide yourself with a plan B in the event you are unable to obtain a SMSF loan. In the meantime, we will watch closely with the federal election nearing as with a high probability of change of Government – time is running out for SMSF Loans.
Ivan Filipovic is a leading SMSF Specialist Advisor with Redwood. Ivan is a Self Managed Superannuation Specialist with over 20 years provides a range of services across all sectors of Self Managed Superannuation, Property and Finance with an emphasis on long term wealth strategies. Ivan is a Chartered Accountant, Financial Planner, ASIC registered auditor, Mortgage Broker, Tax Agent and Licensed Property Professional.
Disclaimer – The content has been prepared by Redwood Wealth Pty Ltd & Redwood Advisory Pty Ltd without taking account of the objectives, financial situation or needs of a particular individual and does not constitute financial product advice. This article should not be considered personal financial advice as it is intended to provide factual information only.
Ivan Filipovic is an authorised representative of First Mutual (AFSL 423710). Redwood Wealth is a Corporate Authorised Representative of First Mutual (1244359)