Banker Sinclair Taylor looks after the trustees of self-managed superannuation funds when they come to Westpac looking for an investment loan, and throughout the years he has seen borrowers come in with very unusual requests and exotic plans.
His advice to the trustees is to keep it simple. "We like plain vanilla," Taylor, the head of Westpac's SMSF trustee division, says.
This is good advice, given the close scrutiny SMSF borrowing arrangements are being given by the Australian Securities and Investments Commission (ASIC) and the Australian Taxation Office (ATO).
Taylor says the SMSF borrowing market is small but starting to grow fast. He estimates about 30,000 of Australia's 480,000 self-managed funds have loans and the bulk of that borrowing is being used to invest in property. In dollar terms, the market is worth between $6 billion and $7 billion.
He expects to see demand increase. "As cash rates come off and equities remain volatile, a lot of trustees are looking for the security of property. That is what they tell us when they come in to talk about a loan.
"We are also seeing more brokers selling the product. There is very strong growth in applications from mortgage brokers."
ASIC highlighted borrowing as a concern in a review of advice to trustees of self-managed funds, published in April.
ASIC says it sees evidence of several inappropriate arrangements involving loans, such as long-term loans being arranged for older investors, who are likely to retire before they have finished paying off the loan. ASIC has concerns about loans used to acquire an asset that is the only asset in the fund. Super funds must have an investment strategy, and that strategy will usually involve a requirement for some asset diversification.
And the regulator says trustees are not always advised of the high upfront costs of a geared property investment.
This year the ATO issued a warning about inappropriate SMSF borrowing arrangements. Its concern is that trustees do not understand that a geared property investment in a super fund is a more complex financial transaction than taking out a standard mortgage.
For example, until the asset is fully paid for, it must be held in a separate security trust (also called a bare trust).
Another requirement is that the loan must be limited-recourse, which means that if the borrower defaults, the lender can take possession of the asset used as security but no other assets of the fund.
Most lenders require trustees to give personal guarantees.
One rule that causes a lot of confusion is that borrowed funds can only be used to purchase what is called a "single acquirable asset". A block of land is a single acquirable asset, but if the land is subdivided, the subdivision would be treated as separate assets and the ATO would rule that the trustee had breached the borrowing rules.
SMSF Professionals' Association of Australia technical director Peter Burgess says the single acquirable-asset rule limits the extent of renovations that can be made to a property.
"In practice, this means alterations to a property cannot be made if they fundamentally change the character of the asset," Burgess says.
When Westpac's Taylor talks about keeping things simple, he means the bank prefers to lend on residential property and "non-specific" commercial property. It will not get into areas such as agricultural property. Taylor says the asset must be a "going concern", which means it must be able to produce income for the fund when it is acquired.
A partner at law firm Kemp Strang, Vicki Grey, says there are always trustees who want to push the envelope, such as when two or more self-managed funds want to invest together and borrow to acquire a single property. In other cases, a trustee will approach two lenders to jointly finance an investment.
Grey says banks like to keep their SMSF loan deals straightforward and trustees need to recognise this.
The head of technical services at AMP's SMSF administration division, Philip La Greca, says many trustees let themselves down by ignoring the administrative workload that comes with an SMSF loan.
"People are going out to buy a property for their self-managed fund. They sign all the paperwork in their own name and then they transfer it into the fund.
"In some cases they acquire the asset and set up the super fund afterwards. The ATO would see this as an example of poor administration," La Greca says.
"What people need to recognise is that if they want to get a loan and use it to buy a property for their super fund, they need to have the fund and any other necessary structures in place before they do the deal."
A director of the SMSF auditing firm Super Sphere, Belinda Aisbett, agrees that lack of attention to administrative details lets people down.
"We see clients who do not set up their bare trusts properly and do not manage the transfer between the bare trust and the super fund properly," Aisbett says.
"Another area where problems arise is refinance.
"Personal guarantees might not be refreshed. Don't assume that because a bank is involved everything will be OK.
"The ATO has a problem with things like that, and it is a complicated and expensive exercise to correct structural defects down the track. It is very important to get advice before doing this and to work through the process carefully."
Simplicity the key
Keep it simple. Assets should be residential or commercial properties without complex holding arrangements. Banks don't want to lend on complicated arrangements and the regulators don't like them.
Banks prefer to lend on assets that are producing income that can go to repay the loan.
Review your fund's investment strategy to make sure there is nothing to stop you from borrowing. Make sure the investment fits in with the overall strategy.
Do all the admin work before borrowing. Have a security trust (also called a bare trust) in place to hold the geared investment.
See an adviser to make sure you understand the rules, particularly the single acquirable-asset rule.