Wed 14 Nov, 2018
5 Things to Consider Before Applying for an SMSF Loan
So you’re thinking of applying for an SMSF loan to purchase an investment property? Luckily, with a self-managed super fund, you can not only use your super to invest in property, but you can also secure lending to assist your fund with the purchase. This is thanks to a specific type of loan called a Limited Recourse Borrowing Arrangement (LRBA); more commonly referred to as an SMSF loan.
While applying for an SMSF loan can be a great way to leverage your super balance for larger investments, there are risks and responsibilities as well. So, before you go rushing in to the auction, there are some important factors you should consider first. In this blog, our Squirrels will be discussing the 5 important things you need to consider before applying for an SMSF loan.
5 Important Considerations Before Applying for an SMSF Loan
1) The Location of Your Property
One major factor that lenders take into consideration before giving you an SMSF loan is the location of your investment property. Lenders generally charge different interest rates depending on where the property is located. So make sure you are aware of the different interest rates the lenders you’re considering charge for a property in a Metro area, in an Inner-city area and in a Rural area.
Lenders consider properties in rural areas to be riskier, so you may need a larger deposit to secure lending.
2) How Much of Your Super Balance to Use on the Deposit
One of the benefits of buying an investment property with your super is having a large deposit at your disposal. Many Australians simply can’t afford to save for a deposit on an investment property. In fact, many Aussies still rent their home. However, by using your super as a deposit, your SMSF can take a step towards property ownership.
But remember, just because you have $200,000 in your super, it doesn’t mean that you can put it all towards a deposit. Using your entire super balance as a deposit on an investment property is generally not realistic - as there are additional costs to consider. These include, but are not limited to, the legal fees, valuation fees, stamp duty and inspection fees.
Additionally, you may want to diversify your portfolio by investing a proportion of your super into other assets. However with an SMSF, the amount you allocate towards your investment assets is entirely up to you.
3) Stress Tests for the Loan Interest Rate
Most SMSF loans have a variable interest rate. This means the interest rate fluctuates over time as it is based on the underlying index from the Reserve Bank Of Australia.
So when calculating your mortgage repayments, remember that the interest you pay on a variable rate loan could go up as well as down. That’s why it’s imperative to calculate stress tests for your SMSF loans interest rate.
The Rate City Mortgage Stress Calculator is a good tool to find out if your super could withstand a higher interest rate than what the variable rate currently is.
4) Additional Costs for Lending in an SMSF
If your SMSF requires lending to invest in property, then you will need a Bare Trust and Bare Trustee. These are necessary in order for your fund to secure the SMSF loan. Your fund will also need to be set up as a corporate trustee structure - not an individual trustee.
The costs of these services can sometimes be upwards of $2,000 - $5,000 with some SMSF providers. However, at Squirrel, we include all these services as standard within our flat-rate SMSF setup fee.
5) The Risks of Lending in Your SMSF
Although there are many benefits to purchasing an investment property with your super, there are also risks, especially when an SMSF loan is used. As with all lending/gearing, the investment returns depend on the rental income and the capital growth of the property being greater than the borrowing and ongoing costs to maintain the property. The higher the level of borrowing against the value of the property, the greater the risk that costs could be higher than the returns.
Another important factor to consider is that while a property is in an LRBA structure, you are prevented from significantly changing it. This means you cannot renovate the property with major structural changes or building work. That’s why it’s important to ensure the property you want to invest in is as tenant-ready as possible before applying for an SMSF loan.
Do you have any questions regarding lending for your self-managed super fund? We can help! Book a free consultation here.