Busting the myths of SMSF borrowing
People are often misinformed about the processes and requirements of SMSF borrowing, particularly regarding lender policies and documentation.
Myth 1 – Large super balances can easily access loans
If your client is sitting on a generous super balance this doesn’t necessarily mean lenders will be falling over themselves to offer a loan. The fund itself must prove that the full loan amount can be afforded by drawing from specific forms of income, primarily:
2. Rent/income from the asset
3. Return on other assets within the fund
Lending can get especially complicated with a typical self-employed applicant. I often see a newly created fund, where there is not a great track record of contributions. However, after creating a plan with their adviser and setting up the fund, the SMSF owner is intending to contribute going forward.
Where there isn’t a proven history of two or more years’ regular contributions, only some lenders will consider lending on this. You can, however, prove the individual's capacity through direct contributions to the fund. This is normally done by supplying a lender’s serviceability calculator for individual borrowings showing the contributions as an additional liability.
It is worth noting that of the lenders that do accept ‘projected contributions’ of this type, some cap the annual amount you can use, regardless of the capacity available.
Myth 2 – Minimum fund balances
There are two distinct parts to consider when advising clients on SMSF borrowing in relation to a minimum fund balance. The first is what is in the client’s best interests in relation to their individual risk profile and investment needs.
The second part, which I will cover here, is what is acceptable to a bank. Some lenders are still comfortable with the fund using its full balance to complete a purchase, meaning that there is no minimum amount that has to be left in the fund. These lenders mitigate the associated risk by insisting on a financial advice certificate (this is covered in more detail in the next point). Others – and this is more common following the recent APRA changes – have adopted a utilisation policy. The most common amount is 10 per cent, ie, 10 per cent of the security’s value must be left in the fund after the transaction as liquid assets (a $350,000 house purchase would mean $35,000 needs to remain in the fund).
This clause is treated in isolation from the fund’s capacity to borrow. Even if the fund has a large surplus of income, if the post-transaction asset position isn’t at least 10 per cent, the loan won’t be approved.
Myth 3 – Legal and financial advice
Surprisingly, I am still asked whether these documents are required. Particularly with the independent legal advice piece, the answer is, absolutely!
Every lender will require independent legal advice to be given about the personal guarantees that are required. This is to ensure that the parties understand their rights and responsibilities as a guarantor, and also to understand how these guarantees may impact them personally away from the fund.
Recently, one of the major lenders in the SMSF space removed the need for financial advice certificates. They have the trustees sign an acknowledgement form instead. Most other lenders will require a pro-forma of some description signed by the customer’s adviser in relation to the transaction. With a few exceptions, the wording can’t be changed and must be signed as presented.
Both financial and legal advice should be discussed with the trustees before a loan application is even considered. Typically, these forms are actually not issued or requested until formal approval is given by a lender. I have heard of situations where a customer’s adviser has refused to sign a certificate because of the wording. Given when the documents are issued (after formal approval), this would mean that the customer was already unconditional on the property purchase.
It is therefore prudent to make sure the client’s adviser is comfortable with the wording prior to a loan application. This may, in fact, guide the lending selection.
Myth 4 – New properties and SMSFs
Every SMSF lender has its own policy and appetite for security types. Some actually don’t want new properties (or they have to be considered on a case by case basis). Regional and mining towns are also sometimes an issue.
Some lenders are undoubtedly better with commercial properties and SMSFa than they are with residential. One major lender has withdrawn from SMSFs for residential properties altogether, but still has a very flexible attitude to commercial SMSF loans.
The main message here is to be aware that not all security is viewed in the same way when a loan is undertaken by an SMSF. Lenders tend to be more conservative.
Greatest caution needs to be exercised with new and off-the-plan properties (for more than one reason). It is no secret that this is where the most activity from property marketers occurs, and a lot of the policies around this type of security tackle that issue (whether the lenders admit it or not).
A great opportunity for those in the know
As with other areas of financial advice, technical expertise cannot be a half-way measure. It is needed for the whole shebang, not merely until the decision to buy is made. For SMSFs, the story doesn’t end when it comes to borrowing.
In this respect, executing funding for an investment strategy is no different to other areas that trustees seek help with. It forms part of the broader advice needed, and is a vital component if the trustee is to reap the full benefits of SMSF property investment.
Samantha Bright, director, Thrive Investment Finance