Is SMSF Lending Right for You? Key Considerations Before Borrowing

Self-Managed Super Fund (SMSF) lending has emerged as a powerful strategy for those looking to use their superannuation for property investments. But like any financial venture, SMSF lending has unique rules, risks, and responsibilities. If you’re considering borrowing within your SMSF, here’s what you should know.

Grasping SMSF Lending Basics: Essential Terms & Rules

SMSF loans operate within a specific regulatory framework. The SMSF itself, managed by trustees, must pass the “Sole Purpose Test”, meaning all activities and investments are strictly for providing retirement benefits. This includes any property purchased through the fund. It’s also important to note that SMSF loans follow a Limited Recourse Borrowing Arrangement (LRBA). This setup ensures that in the event of default, only the property purchased can be claimed by the lender safeguarding any other fund assets.

For example, Imagine purchasing a residential property with your SMSF. That property must produce income for the fund, and unfortunately can’t be used for personal reasons such as buying a beach house or weekend getaway. Whilst residential investments are strictly for investment purposes only, commercial properties may be for investment or owner-occupied purposes which means you can operate your own business out of the premises.

Financial Health Check: Can Your SMSF Afford a Loan?

Lenders assess SMSF loans differently from traditional loans, often requiring more stringent financial health criteria, such as high liquidity and a diversified asset base. While rental income can serve as a primary means of covering the loan, higher interest rates often mean that a portion of employer superannuation contributions (11.5%) – which would typically go into an industry super fund, will instead need to be directed into the SMSF to help meet repayments. 

SMSF funds must remain stable even after acquiring the property, so maintaining a strong buffer is essential. Loan providers like WLTH, La Trobe, and Liberty are popular options, as many major banks offer limited SMSF lending.

Quick Tip: Plan for a minimum liquidity level within the SMSF post-settlement. This ensures you can manage repayments and unexpected costs, particularly in the face of rental income fluctuations or unexpected property expenses.

Potential Benefits of SMSF Property Investments

There are notable advantages to SMSF lending, especially for those with long-term growth in mind:

• Control and flexibility: SMSF trustees have greater control over their investments, from choosing the property type to designing an investment strategy tailored to retirement goals. Unlike many industry funds, SMSFs allow direct property ownership, providing trustees with more diversified investment options.
• Tax Efficiency: Rental income from SMSF property investments is taxed at a concessional rate, and in the pension phase, you may benefit from even lower or tax-free income.
• Capital Growth Potential: Property investments within SMSFs can appreciate over time, adding substantial value to your retirement savings.

Evaluating the Costs and Risks of SMSF Lending

Due to limited recourse borrowing, SMSF loans tend to have higher costs than standard property loans. Additionally, setup fees, valuation costs, and ongoing management expenses should be considered, making SMSF lending most beneficial for those with higher balances.

Key Considerations:

• Market Risks: Like any investment, property values fluctuate. A downturn could impact your SMSF overall balance, especially if your fund is heavily invested in property.
• Compliance & Administration: Trustees are responsible for ensuring the SMSF complies with regulations. This requires careful record-keeping, regular audits, and a solid understanding of superannuation laws.

Residential vs Commercial Property: Which is Right for Your SMSF?

SMSFs can invest in a variety of properties, but each type comes with its nuances.

• Residential: This is strictly for investment within an SMSF. Residential properties often have lower maximum LVRs (Loan-to-Value Ratios) but may come with additional features like offset or redraw options.
• Commercial: SMSFs can purchase commercial property for investment or business use if the fund owns the business. Commercial properties also the advantage of tenant responsibility for ongoing expenses, potentially boosting cash flow for the fund.

Professional Advice: A Smart Move for SMSF Borrowing

Given SMSF lending’s complexity, engaging an SMSF specialist or financial advisor is advisable. Not only can they guide you on structuring the SMSF correctly, but they can also help with compliance and crafting an investment strategy that aligns with your retirement vision.

Below is a list of professionals and their roles that you should consider when using SMSF:

• Accountant: Setting up the SMSF, bare trust, and corporate trustees and providing the best advice around structures.
• Financial Advisor: Giving you personal advice on how to invest/diversify.
• Buyers Advocate: To help you find the best asset, whether it be a residential investment, commercial owner occupied for your business or for investment to ensure you see growth in the future.
• Legal/Conveyancing: To help settle the deal – but also provide you with legal advice as you will be required to sign a personal guarantee due to the super contributions you are making from your employers/income.

Friendly Reminder: Legal advice is mandatory for SMSF loans, and having independent guidance can prevent costly mistakes and ensure your fund stays compliant.

Making the Right Decision for Your SMSF

SMSF lending can be a valuable addition to your retirement strategy, offering growth potential and tax benefits. However, it requires careful planning, a deep understanding of regulations, and the financial capacity to manage the commitment. At Entourage, we’re here to help guide you through every step, ensuring your SMSF investments are sound, compliant, and aligned with your retirement goals.