A guide to limited recourse loans for SMSF trustees
Limited Borrowing Recourse Arrangements (LRBA) for self-managed superannuation funds (SMSFs) were given the green light by the Australian government as a way for SMSF trustees to borrow money to buy property.
The main benefit is that in the event that you default on your mortgage, you are liable to sell the single (or multiple) properties you purchased while the other assets in your SMSF are protected.
There are few lenders that offer SMSF loans but what are the essential facts you need to know about an LRBA to ensure your retirement nest egg is safe?
How much can you borrow?
- A limited recourse loan to buy residential property: Borrow up to 75-80% of the property value.
- Commercial property: Up to 70% of the property value for standard commercial properties like an office unit.
- Discounts: Most lenders add a margin to their normal residential loan rates for SMSFs but these margins vary significantly.
Call us on 1300 889 743 or fill in our online enquiry form to discover if you qualify for an LRBA loan for your SMSF.
What is an LRBA?
To explain, trustees of SMSFs are actually prohibited from borrowing under the Superannuation Industry (Supervision) Act 1993 (SIS Act) with the only exception being under an LRBA.
To do this, a separate trust entity called a Bare Trust (essentially an empty trust) is set up to legally own the property on behalf of the SMSF.
This is known as the “single acquirable asset” in tax terms but keep in the mind that it can actually apply to multiple titles of land such as multiple units on one title, a stratum title where the unit and car park cannot be sold separately or a factory, warehouse or workshop built across two titles.
It’s through this structure that you’re able to borrow to invest in property. Bear in mind that you need a new bare trust if you want to invest in another property.
What are the pros of limited recourse loans?
- It can help to diversify your SMSF’s investments into other assets like commercial property.
- If you’re a business owner, you can buy business premises.
- It protects the other assets in your SMSF from “recourse” or from the lender selling those assets to recoup any losses that weren’t covered by the sale of the property you purchased.
- There can be tax benefits such as capital gains tax (CGT) concessions. The maximum CGT rate drops from 15% to 10% where a property is held for more than 12 months.
- As long as you’re not too close to retirement age, you can actually use concessional super contributions in order to pay down your loan faster. You don’t get this benefit with a standard home loan!
What are the drawbacks and risks?
Consider whether the purchase of the property will actually put you in a better position for retirement.
That means taking into account rental income and capital growth versus the mortgage interest and the cost of property maintenance and repairs.
- You’re investing so you’re still at the mercy of the property market.
- There is illiquidity risk if the property makes up a large portion of the SMSF’s total assets. If the property cannot be sold quickly in the event of default, it may impact on an SMSF’s ability to meet its obligations to members.
- Borrowing itself can affect the SMSF’s ability to meet member benefits obligations.
- SMSF and superannuation legislation changes on a regular basis and with each successive government. It can be hard to follow these rule changes and breaches can cost you thousands of dollars in fines depending on the size of your SMSF.
Do I need to provide a personal guarantee?
A lot of lenders now are asking for personal guarantees from SMSF members to protect themselves.
A personal guarantee doesn’t mean you have to chip in money every month for the mortgage repayments.
However, if the SMSF blows up, the lender can come after you if the sale of the asset doesn’t cover the loan.
While it may seem to go against the concept of “limited recourse”, lenders are still able to impose this requirement because there are very few lenders and major banks that operate in this space.
When it comes to a limited recourse loan, lenders are much more interested in mitigating risk than staying competitive.
That means the banks may still be able to go after your personal assets should the SMSF default on its mortgage repayments.
Not all lenders need a personal guarantee!
If the SMSF is able to stand on its own with enough liquidity in the fund then the lender may waive the personal guarantee requirement.
For example, if you buy a commercial property for $800,000 and you put in $500,000 as a deposit and earn $50,000 a year in rent, the cash flow in this transaction is strong enough that the lender may not need a personal guarantee from you.
That’s because the Loan to Value Ratio (LVR) or the amount you’re borrowing compared to purchase price is 37.5% (not including the costs of completing the purchase).
With just a $300,000 loan amount at a 7.00% interest rate, your annual repayment is just $21,000.
This means the rental amount is more than sufficient enough to cover the loan repayment and still have a huge buffer leftover.
Despite this, the decision to waive the personal guarantee requirement depends on the lender.
We can help you find a lender that doesn’t require you to provide a personal guarantee for an LRBA loan!
Home Loan Experts has a wide variety of lenders to choose from and credit expertise in SMSF and LRBA lending.
Call us on 1300 889 743 or fill in our online enquiry form to discover if you qualify for a limited recourse loan.
Does your SMSF even allow you to invest in property?
Before applying for an LRBA loan, you should find out whether your SMSF trust has the power to invest in property.
That’s why it’s important to speak to your accountant and get legal advice first.
They will also be able to properly assess your financial situation and advise you on whether going into an LRBA best fits your investment strategy.
What happens at settlement?
The lender will provide the loan to the bare trust and the SMSF will pay the balance of the outstanding purchase price.
The property is then registered in the name of the bare trustee of the bare trust.
The bare trustee will then grant a mortgage and provide a guarantee that the lender has the right to sell the property or asset in the event of default.
The SMSF is entitled to income from the property via the bare trust structure but it must also meet expenses related to the property as well as the actual mortgage repayments.
When can I removed the LRBA?
You can only remove the LRBA once the home loan has been completely paid out.
At this stage, you can choose to either keep the property in the bare trust or close or collapse the bare trust and transfer the property to the SMSF trustee.
Again, it’s important to get independent legal and tax advice to ensure that you make decisions that are in your best financial interests such as minimising your tax obligations.
Aren’t limited recourse loans being banned?
No! However, the idea had been discussed by the Australian government and several industry bodies.
In late 2015, the government rejected a Financial System Inquiry (FSI) recommendation to totally ban direct borrowing to SMSFs via LRBAs.
The FSI had raised concerns that the type of lending that was happening was putting the banking system at heightened risk but the government believe that the data wasn’t there to justify a total ban.
The Self-Managed Independent Superannuation Funds Association (SISFA) soon after came out to support the government’s move.
It said that LRBAs should remain an option as part of a properly structured retirement plan, provided that the SIS Act were enforced.
Do you need a limited recourse loan?
We’re experts in LRBA and SMSF loans!
Discover if you qualify for a loan so you start borrowing for your SMSF. Call us on 1300 889 743 to speak with one of our specialist mortgage brokers and tell us a little about your situation by completing our easy online enquiry form today.