A guide to SMSF borrowing

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on January 17, 2022 Fact Checked
A guide to SMSF borrowing

Borrowing through an SMSF can be tricky, time-consuming, and sometimes risky - so it’s important to know what you’re doing.

It seems nothing to do with self-managed super funds (SMSFs) is simple or easy. As always, there are a number of strict rules and regulations when it comes to borrowing through an SMSF. You can only do it for a few reasons but to avoid getting in any trouble, make sure you know what you’re doing before signing any dotted lines.

In this article, we’ll discuss:


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Looking to take control of your retirement? This table below features SMSF loans with some of the most competitive interest rates on the market.

Lender

Variable
More details
SELF MANAGED SUPER FUND LOAN
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
SELF MANAGED SUPER FUND LOAN

SMSF 80

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

Ocean SMSF (No Offset) (Metro) (Principal and Interest) (LVR < 60%)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF 70 (Refinance)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF Loan (Interest Only) (LVR < 60%)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

Liberty SuperCredit SMSF (LVR < 60%)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF Residential

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF 70 (Purchase) (New Customer)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

Base criteria of: a $400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to be made on variables as selected and input by the user. All products will list the LVR with the product and rate which are clearly published on the Product Provider’s web site. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. *The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Rates correct as of May 26, 2022. View disclaimer.


When can you borrow money through an SMSF?

There are only a few scenarios in which you can borrow through your SMSF. According to the Australian Taxation Office (ATO), you can borrow money through an SMSF for:

  • Meeting benefit payments due to members or to meet an outstanding surcharge liability (can only borrow the money for 90 days; borrowings can’t exceed 10% of your fund’s total assets)

  • Covering the settlement of security transactions (can only borrow money for seven days, can’t exceed 10% of fund’s assets). For this type of borrowing, you must not have believed it would be necessary at the time of the transaction

  • Instalment warrants or limited recourse borrowing arrangements (LRBA), if certain conditions are met

The most commonly known type of SMSF borrowing is called an LRBA, which is how SMSFs can borrow money to purchase assets like property or shares.

How does SMSF borrowing work?

If you’re looking to purchase an asset through your SMSF, you may be consider using an LRBA. You could be able to borrow money from a ‘related party’ to purchase an asset, but this party should be kept at arms-length to avoid being taxed at a higher rate (45% rather than 15%). Instalment warrants are another option - but we’ll talk about that later.

An LRBA involves taking out a loan from a third party lender to purchase a single asset (or collection of identical assets of the same market value) - such as a property or shares - to be held in a separate trust. Any investment returns made goes to the SMSF trustee/s, and to safeguard any other assets held under the trust if the loan defaults, the lender’s rights are limited to the singular asset.

There are a number of superannuation law requirements for LRBAs that must be met by super trustees according to the ATO. To give a brief rundown of these laws, the money must be used to purchase the asset (property, shares) and can also be used to cover any related expenses. However, borrowed monies can’t be used to improve (renovate) the asset. It also must be held in its own separate trust.

There’s a much longer list on the ATO website and, if the conditions aren’t satisfied, borrowing money through an SMSF can result in a contravention of one or more super laws - and this can have civil or even criminal consequences. So it’s important to read the full list before borrowing through your SMSF.

Clearly, it’s a can of worms. The ATO warns that LRBAs definitely aren’t right for everyone, and urges SMSF trustees to ask themselves questions about the product being offered before deciding. Some of these questions include:

  • Who will be the lender and what will happen if borrowing rates reduce or rise?

  • Can the loan be called in early?

  • Can your loan be sold to another party and terms of the loan altered?

Additionally, the ATO poses questions about the asset being purchased under the LRBA, how it works, and whether or not it will end up being a worthy investment. Some of these questions include:

  • Is the asset being offered of good quality, and what’s the value of the asset you’re looking to buy? If you’ve been given a valuation, is it reasonable? Is there a way to check?

  • What are the fees and costs of the loan? Will you be paying commissions to the person who arranges your loan, and if yes, are you comfortable with that?

  • Does the asset need to be insured and, if yes, will the SMSF have the money available to pay insurance costs?

  • Given LRBAs are generally used for long-term investments, will your SMSF have enough money left over to pay other administrative expenses such as accountant and auditor fees?

Just as any investment decision being made for your SMSF, an SMSF loan must be in line with your trust's investment strategy and be for the purpose of providing retirement benefits to SMSF members.

SMSFs & property: What are your options?

While you can use an LRBA to buy any singular eligible asset - most commonly, SMSF loans are used to purchase property. SMSFs can own residential or commercial property, but commercial is generally the more popular choice.

Either way, the property must comply with a set of rules if being purchased through your SMSF. According to Moneysmart, these rules include:

  • Being able to meet the ‘sole purpose test' - to make sure it’s being purchased with the sole purpose of providing retirement benefits to fund members

  • The property mustn’t be acquired from a related party of a family member

  • The property can’t be lived in by a fund member or any related parties to the fund members

  • The property can’t be rented by a fund member or any related parties to the fund members

The last rule can be waived if the property is a commercial premises; it can be leased to a fund member for their business endeavours, but certain rules must still be followed. For example, it must still be rented to said person at ‘market value’. Basically, you can’t cop a bargain and rent a giant property for $10 per week; it must still be primarily used to generate retirement benefits for all SMSF members.

When it comes to purchasing property through an SMSF, it’s important to differentiate it from a regular property purchase. Particularly, this will be evident in the fees you’ll be charged, as buying through an SMSF will come with fees including:

  • Upfront fees

  • Legal fees

  • Advice fees

  • Stamp duty

  • Ongoing property management fees

  • Bank fees

While some of these are pretty standard/unavoidable (stamp duty and property management fees), some are specific to or will be higher due to purchasing through an SMSF. For example, you’ll likely have higher advice fees, possibly due to using an SMSF adviser; additional legal fees for creating the separate trust; or you may even need to adjust your investment strategy.

Another consideration of purchasing through an SMSF is the risk if anything goes south. If the application isn’t properly constructed or compliant, severe fines of over $200,000 can apply. This is why it’s strongly recommended to do your due diligence and seek out a mortgage broker and accountant to walk you through the process.

Additional risks of a geared SMSF property could include:

  • Higher costs: Another consideration is that the loan will likely come with higher fees, interest charges, and so on due to its higher risk

  • Cash flow: You must pay off the loan directly from your SMSF fund. If you fall short, you can’t make up for it with personal contributions. So, you must have the cash flow ready to cover all mortgage repayments, maintenance, etc.

  • Hard to cancel: If it’s not set up correctly, getting out of an SMSF property loan is hard. You may end up needing to sell - which given the additional costs of buying can mean you incur an overall loss

  • Possible tax implications: Since the property is owned by the fund and not you, you can’t offset any tax losses from the property against your personal taxable income. This means you can’t negatively gear the property You can, however, offset the losses against the SMSF fund’s taxable income, but the tax rate in an SMSF is typically only 15% rather than your marginal tax rate, so don’t expect to save a lot on tax.

  • No alterations to the property: That is, while you’re still paying off the loan

Of course, there are benefits to buying property through an SMSF - particularly if you’re a business owner as you can lease it back to yourself - but the risks should also be considered.

Also read: A guide to buying property through an SMSF

Can you borrow to invest in shares through an SMSF?

You can also borrow money to invest in shares, but under certain conditions. As mentioned, the shares need to be considered a ‘single asset’ - this still works if it’s a collection of identical assets of the same market value. For example, if you were buying 100 shares in the same company, this could be considered a single acquirable asset as they are worth the same value and being purchased at the same time.

A collection of shares can be purchased using an LRBA structure, but if you’re buying different shares or shares at different times, you’ll need to take out a new LRBA each time. Alternatively, you an use an instalment warrant to purchase shares - this means you (the SMSF) makes an initial payment on a share and then repay the rest over time.

Of the big four, instalment warrants are available through Commonwealth Bank (through CommSec), NAB (through nabtrade), and Westpac. To meet the limited recourse borrowing requirements, internal structures - such as a bare trust - must be put in place to ensure the arrangement is compliant.

When borrowing to invest in shares, it’s important to consider the potential risks that could impair you from repaying your debt. Typically, the value of shares can be more volatile than the value of property. If your shares drop in value significantly, you risk receiving a margin call where you’re forced to put more funds in to cover the risk to the lender. Again, it’s important to remember keeping up with your repayments is the responsibility of your SMSF - not you individually - so all repayments must come from your SMSF.

What happens if you default on your loan?

In a normal borrowing situation, if a person defaults on their loan, the lender might look to seize anything they can to recoup their losses. Purchasing assets through an SMSF means that these assets will all be held in separate trusts. This means that if the loan defaults, the lender only has access to the asset in one trust, hence the term ‘limited recourse’. This protects all other assets that may be held by the SMSF.

This can provide an added layer of protection when purchasing property. Instead of a lender having free reign to all of your possessions, they only have the ability to recoup their losses on the singular asset that was purchased. Though defaulting on a loan is never ideal, knowing that the rest of your assets are untouchable can be a perceived benefit of purchasing assets through an SMSF. This is also why SMSF borrowing is inherently riskier for the lender, which is why you might be charged a higher interest rate.

Is it worth borrowing through an SMSF?

There are pros and cons to borrowing through an SMSF. You may find that the benefits outweigh the drawbacks, or vice versa. Either way, it’s important to understand both sides of the coin before making any decisions. Not to mention - it’s highly important to know what you’re doing to avoid copping a massive penalty.

Borrowing to purchase property or shares can be a good way to diversify your investment portfolio if you’re unable to do so solely with member contributions. However, you should make sure it’s in line with your investment strategy and risk portfolio. Borrowing through an SMSF is inherently more risky than borrowing money yourself. While the risk is minimised to your other assets, your SMSF will need to have a substantial cashflow and navigate a lot of red tape in order to keep up with your loan commitments.

At the end of the day, borrowing through an SMSF to purchase assets is quite common. About $57 billion in LRBA debt was held by SMSFs at the end of June 2021 according to the ATO, so clearly some believe the rewards outweigh the risks when borrowing through an SMSF.

In any case, if you’re unsure about whether borrowing through your SMSF is right for you, you should seek independent advice from an SMSF adviser


Image by Devon Divine on Unsplash

Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered. Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site. Savings.com.au, yourmortgage.com.au, yourinvestmentpropertymag.com.au, and Performance Drive are part of the Savings Media group. In the interests of full disclosure, the Savings Media Group are associated with the Firstmac Group. To read about how Savings Media Group manages potential conflicts of interest, along with how we get paid, please visit the web site links at the bottom of this page.

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Rachel is a Finance Journalist, and joined Savings in 2021. Coming from a background in the FinTech space, her interests include the innovation of lending technology, property, investing, and more. With a passion for educating and informing people about their finances, she hopes to increase the financial literacy of everyday Australians.

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