Choosing the right loan for your self-managed super fund (SMSF) can be challenging. While the premise of a fixed or variable rate remains the same, SMSF loans have the potential to be just like everything else SMSF-related: complicated. Your options are more limited, and all members must agree on the decision… so, it’s important to fully understand each option to decide which is best for you: a fixed or variable rate SMSF loan.
What is an SMSF loan?
First and foremost, let’s explain SMSF loans. An SMSF loan isn’t like a regular home loan or personal loan - it’s known as a limited-recource borrowing arrangement (LRBA). With this type of loan, since it will be taken out by and repaid solely by an SMSF, it is fundamentally different. In the event the borrower is unable to repay their loan, the lender is limited in what assets they can seize to cover their losses. In other words, the rest of the SMSF’s assets are protected, and the lender only has access to the asset secured against the loan.
SMSF loans come with more risk than a regular loan. With this in mind, you’re likely going to be required to pay a higher interest rate than most other loans on the market. According to the latest ATO figures, you can expect to pay roughly 5.10% p.a. for real property or 7.10% p.a. for listed shares or units.
What is a fixed rate SMSF loan?
An SMSF loan with a fixed rate is, in many ways, the same as a regular loan with a fixed rate. Essentially, the interest rate you pay for a certain period of time is fixed, meaning it won’t go up or down in line with market activity and the Reserve Bank of Australia’s (RBA) cash rate. You know exactly how much you will be paying for a period of time, which can help you budget during said timeframe.
What is a variable rate SMSF loan?
Again, similar to any other type of loan, an SMSF loan with a variable rate means that the interest rate you pay may change. If the cash rate goes up or down, your interest rate is likely to move along with it. Lenders are also free to move out of lockstep with the Reserve Bank. Variable interest rates can often be more flexible than fixed rate loans, and may come with benefits such as an offset account and/or the ability to make extra repayments.
Fixed vs variable rate SMSF loans
Before you decide one is better than the other, there are pros and cons to each option that should be weighed up equally. Mostly it comes down to flexibility versus certainty.
Pros of fixed rate SMSF loans
Rate rises won’t affect your interest rate: Like we mentioned, if interest rates go up, your fixed rate won’t be affected.
You know how much you’ll be paying: Fixed rate loans are commonly fixed for between one and five years. Either way, your interest rate won’t change throughout the fixed period.
Cons of fixed rate SMSF loans
Not flexible: With a fixed rate loan, you will usually be capped or unable to make extra repayments or use an offset account.
Won’t benefit from falling interest rates: Since your interest rate is locked in, if interest rates were to drop, this wouldn’t be reflected in the interest rate you’re paying.
Revert rates: Once your fixed rate term ends, you may find that your revert rate is substantially higher than you original interest rate - this can come as a shock to the budget.
Break fees: If you exit a fixed loan early, you’ll likely be subject to a break fee, which is usually a calculation based on the difference between the old rate and the new rate, and how long you had left on your fixed term. This could add up to thousands.
Pros of variable rate SMSF loans
Flexibility With a variable rate loan, you can usually make extra repayments or lump sum repayments whenever you want. You can also typically get a loan with an offset account, which can help you save money and pay off your loan faster.
Refinancing: Typically, refinancing a fixed rate loan will incur break fees. But with a variable rate, you can usually refinance whenever you want - however there may still be other fees such as exit or new loan establishment fees.
Benefit from falling interest rates: With a variable rate SMSF loan, you will benefit if interest rates drop as you’re not locked into your original rate.
Cons of variable rate SMSF loans
Rising interest rates will impact you: Just as you’d benefit from falling interest rates, you will see the opposite effect if interest rates rise. Your SMSF loans interest rate could increase should a lender’s wholesale borrowing costs also increase.
Unknowns: Since you don’t know how much interest you’ll be paying in the near future, it may be more difficult to budget, especially in the early days of property investment when there are multiple other upfront costs.
Should you go with a fixed or variable rate SMSF loan?
When deciding whether to go with a fixed or variable interest rate, there are a few key considerations you should make before landing on your ideal option. You may believe that a fixed rate is better if your SMSF investment strategy is considerably low risk, but fixing your interest rate could end up costing you more, especially if you want to pay extra into your home loan, or refinance and subsequently face break fees.
Historically speaking, fixed rate loans have also attracted higher interest rates than variable loans, though this has changed somewhat in recent years.
Another thing to be wary of is that fixed rate loans provide certainty and stability, but this can be a double-edged sword. When rolling out of the fixed period, you may find the new most competitive variable rates are much higher. If interest rates rise over time while you have a variable rate, your boat can rise with the tide, so to speak. With a variable rate, you can also pay extra into the mortgage to get ahead and to also adjust to a higher repayment figure.
To learn more about whether to choose a fixed or variable rate, read our article on How to choose between a fixed or variable home loan.
There are reasons to opt for a fixed or variable rate SMSF loan, but ultimately, the decision will be completely down to you.
One other stipulation from the Australian Tax Office is that you likely can’t draw down on the loan to make any renovations or improvements to the property for loans arranged after 7 July 2010. So, if you were thinking of going one way or another to generate spare cash for alterations, count it out.
If you want to know how much you’ll be paying for a period of time, don’t want to be hit by rising interest rates, or simply value security - a fixed rate SMSF loan may be for you. But if you want to refinance in the near future, want to use an offset account or make extra repayments, a variable rate SMSF loan might be more suitable.
Before deciding which product is right for you, you may wish to consult a financial adviser or an SMSF adviser.