Property Investing For Dummies: Lending lines for DIY funds

Working out who can lend to SMSFs

Until recently, the question wasn’t so much who could, but who would, lend to super funds. When the rules were changed in 2007, catching the industry by surprise, only about two niche lenders were lending to super funds. Both of these lenders became casualties of the credit crisis in early 2008.

For quite a period, very few lenders were prepared to lend to SMSFs, a situation that has slowly changed. Most of the major lending organisations – plus a few niche lenders – have reconsidered the new laws and now offer specialised loans for SMSFs.

But another important option should be considered – you as the lender.

Regular lenders

Any lender can, potentially, be the source of funds to be loaned to a SMSF under a LRBA. Most of the major banks (except ANZ) have joined the fray and now offer loans to SMSFs.

The advantages of using a major lender is that they source the funds for you, draw up loan agreements as part of the process and do most of the checks required to make sure the loan is being entered into legally. The downsides include that major lenders often charge a higher interest rate than you would normally be able to source if borrowing in your own name.

Importantly, as the loan must be limited recourse, with the lender only being able to seize the asset against which the loan was made, the lender will usually restrict the percentage of the cost of the property that they lend on. Most lenders restrict this to no more than 80% for residential properties and 60% for commercial properties.

You become the lender

Instead of accessing regular lenders for the loan amount nothing is in place to stop you becoming the lender of the borrowed funds to your SMSF.

One reason you may consider this is that you have a surplus of cash in your personal name and your super fund doesn’t have enough money to purchase the property. Another reason may be that you haven’t been able to find a regular lender who is willing to lend against the property you wish to purchase.

Often, it may be that the individual can get better access to borrowed funds than the super fund, or on better terms. If the individual, for instance, owns his own home and has significant equity in personally held investment properties outside of super, a bank might happily lend money to him personally, while having internal restrictions that stop the SMSF qualifying for a loan.

For example, let’s take an individual who owns her own home outright, which is worth $1,000,000. Given the property has no debt, the bank may be prepared to lend $400,000 with a mortgage against the individual’s primary place of residence (her home) at a 7.5% interest rate. The individual could then lend that $400,000 (properly documented) to the SMSF’s bare trust, also for 7.5%. The bank has loaned to the individual and takes the family home as security on a full-recourse loan.

A second loan is then put in place, between the individual and the SMSF. That loan must be limited recourse, under the rules for LRBAs.

Lending money into a SMSF is a tricky area and specialist advice is highly recommended. You can’t just hand your super fund a wad of cash and call it a loan. The loan needs to be documented, and a fair interest rate needs to be paid for the loan by the SMSF (among other requirements). Essentially, the loan agreement needs to be made on an arm’s length basis. If the interest rate is too low, the ATO might see it as the individual trying to make a contribution to the SMSF (which is allowed, but must count against a contribution limit. If the interest rate is too high, it could be a breach of the sole purpose test, because the ATO sees this as the individual receiving a benefit prior to reaching the preservation age. In late 2012, this element was being reconsidered by the ATO. If you’re considering charging an interest rate that’s not a commercial rate of interest, speak to a knowledgeable financial adviser.

It is important to note that no actual limit exists on the amount of money that can be loaned to a SMSF. If an individual is prepared to lend the SMSF the whole of the purchase price, plus the legal costs, then the individual may do that. However, if the loan, for one reason or another, can’t be repaid, and the value of the property when sold means the loan cannot be repaid in full, the lender might lose some of his capital – that’s the limited recourse nature of LRBAs. Under these circumstances, it’s possible the capital forgone could be seen as a contribution to the fund by the ATO, which could create issues with the very strict contribution limits.

From Chapter 8 of Property Investing For Dummies, 2^nd Australian Edition. By Bruce Brammall, Eric Tyson and Robert S. Griswold. Published by For Dummies, March 2013. Wiley Publishing Australia.