The current SMSF lending landscape
Despite the increasing challenges facing SMSF investors in the current climate, there are still options available to obtain a successful loan. SMSF investors need to ensure they weigh up all their options and obtain financial advice from a reputable professional.
Obstacles currently facing investors
“It is a bit of a perfect storm at the moment” says Michael Minter, managing partner at Pitcher Partners, “as you have several factors converging to make it difficult to obtain loans.” The key factors include major financiers exiting the space, particularly regarding residential property, the downturn in the property market and the tightening of policies concerning limited recourse borrowing arrangements (LRBAs). Due to the greater risk associated with borrowing in a SMSF, lenders are naturally being more cautious. This is a trend that Michael has seen recently across his own client base.
Liquidity associated with running SMSFs is one of the primary challenges facing borrowers says Chris Straw, director at You’re Welcome Finance. Increasing liquidity requirements when borrowing money to buy property and an increasingly volatile share market mean that investors need to secure greater capital. The costs to run and maintain an SMSF are also significant. “People are looking to establish an SMSF so they have more control over their investment strategy but are sometimes unaware of the costs in establishing and maintaining their own fund,” emphasises Mr Straw.
Zsuzsa Schmidt, Director of Erudite Finance sympathisers with the investors as they struggle to feel confident in the ever-changing regulations and policy fluctuating from the government and the Australian Prudential Regulation Authority (APRA) . “These poor investors have to keep on top of frequent changes and have not always been given clear direction and guidance to make the right choices for their future.”
And as if this wasn’t enough, the threat that Labor, if elected, will ban LRBAs as part of its housing affordability package is likely to be in the back of both lenders and borrower’s minds.
Types of lenders in the loans market?
Although servicing continues to be one of the biggest obstacles facing investors there remains alternatives in the loans market, particularly from second tier institutions.
According to Sean Murphy, associate director at My Mortgage Freedom, “the lenders I have always used are still very active in the SMSF space” with Liberty and La Trobe Financial picking up most of the SMSF clients due to their affordability and accessibility. In addition, new lenders are entering this niche market with comprehensive solutions. “They are actually paying attention to what the market needs and presenting great products.”
Thinktank, Mortgage Ezy and Australian Financial are some examples of smaller players entering the SMSF loans market.
But as Ms Schmidt states, as with many facets in the SMSF market, “institutions lending in this space are ever changing and all have different requirements, so it is important to do your due diligence and obtain current advice when deciding which one is appropriate for you.”
Tips and traps with related party loans?
With the recent changes to superannuation legislation pertaining to the treatment of assets acquired under a LRBA, more people are turning towards related party loans. However, related party loans are not without their complexity or restrictions. There are many factors that need to be considered to ensure compliance when borrowing from a related party.
Mr Minter has seen less related party borrowing occurring due to the ATO’s prescriptive nature as to how these loans work. “The need to comply with the ‘safe harbour’ rules are a critical piece of the advice. If you choose to borrow from a related party then you must prove to the ATO that the arrangement with the related party was on the same commercial terms that you would have got with an unrelated party. It is not on ‘arm’s length’ terms if the bank would never have lent you the money in the first place.” Therefore, it is critical for practitioners to ensure they follow the safe harbour rules if they are to withstand ATO scrutiny.
Other compliance traps include not having an investment strategy or retirement plan, failing to understand your obligations and assets not being held in the Trustees name. Mr Straw believes that perhaps one of the biggest traps is receiving minimal or insufficient advice, “t is critical to obtain independent financial advice that is acting in the best interests of the client.”
Borrowing strategies with related party loans
As many lenders are tightening their policies and requirements for SMSF property loans, related party loans can be an alternative strategy for borrowing. However, it is important to be aware of the restrictions, as there are limitations against transactions involving related parties of an SMSF fund and relatives of its members. For example, “no one associated with a fund should get a present-day benefit from its investments and a fund needs to be maintained for the sole benefit of providing death or retirement benefits to its members or its dependants” says Mr Straw.
Mr Murphy does highlight that “for the right person, related party loans can be a brilliant strategy for borrowing. I have had it work exceptionally well for some of my clients, however as these can consume a client’s borrowing power, considerable thought must be given.”
However, with the ATO heavily analysing loan approvals from related parties and requiring lending to follow the arm’s length rules, it is likely that we will continue to see this structure of borrowing become less common says Mr Minter.
Improving your chances of obtaining a loan?
Mr Straw believes that despite the complicated rules that govern SMSFs “they remain a good investment strategy to allow you to manage your own investment strategy.
Having sufficient capital is critical says Ms Schmidt. “Making sure you have enough of a nest egg and have sufficient income going into the fund so that you are not solely relying on rental payments from your property.”
Another crucial factor is that the liquidity of the fund is well considered. You are going to struggle in terms of obtaining finance if you don’t have the equity in the super fund to begin with. These days most banks are pushing the loan to value ratios (LVR) down, so you might only be able to borrow 50-60 per cent of the purchase price which obviously means you have to have the remainder already in your fund” says Mr Minter.
Of course, there is also the issue of advice. “In any of these sorts of arrangements it does come down to getting some good advice early in the piece before you go down that track. You must be prepared and organised. Gone are the days where you can attend an auction and then choose to set up an LRBA. You need to be proactive in your thinking and planning about your portfolio” Mr Minter says.