Why Is Servicing An SMSF Loan So Hard?

Servicing requirements for SMSF loans under the traditional LRBA structure are incredibly demanding which can be frustrating for SMSF trustees but when you crunch the figures it’s not so silly.

How much an SMSF or individuals can borrow and therefore purchase for eventually comes down to two things: their incomes and their deposit.

Deposit

Most SMSF lenders have now introduced minimum liquidity requirements, meaning that not all the funds in an SMSF can be used toward the purchase of a property. These requirements vary from lenders to lenders but a 10% to 20% of the fund value range would cover scenario.

So if your SMSF has a $200,000 balance, only $160,000 to $180,000 will be able to be used toward the purchase of the property. On the other hand, the same $200,000 in the hands of individuals looking at purchasing an investment property can be used in full, which is the first significant difference.

Furthermore, an SMSF will only be able to borrow 80% of a property value at best and more often than not this can go down to 70% or less depending on the type of property being purchased. Meanwhile, individual investors are still able to borrow up to 95% of a property value, which is another massive difference between the two options.

Income

For example, take a couple earning $40,000 each. If they had a $200,000 deposit and were looking at purchasing an investment property outside of superannuation, granted that as the SMSF they have no other liabilities, they could comfortably look at properties worth up to $750,000.

However, the same couple purchasing through an SMSF which would have the same $200,000 deposit could only entertain properties up to $400,000 at a stretch.

That’s a substantial difference which may sound harsh but consider the figures below:

SMSF annual costs:

• Principal and interests yearly SMSF loan ($260,000 over 30 yrs) repayment – $17,900
• Rental costs (property manager, council rates, insurance…) – $5,000
• SMSF Administration (tax returns, audit, ASIC) – $2,000  
• Total costs – $24,900

SMSF annual income:

• Super guaranteed contributions (9.5% of income) – $7,600
• Property rental income – $17,000
• Income from $40,000 left in the SMSF offset account – $2,200
• Total – $26,800

$1,900 per year is not much of a buffer and you would not want the banks to lend much more based on those figures.

We see clients on really good incomes struggling to purchase the properties that they want to purchase through their SMSF because of the above model.

So there it is, the banks are being reasonable and we just have to capitulate and purchase cheap properties? Well, that would not in the spirit of this firm to just accept it as is.

A number of things can be done to mitigate these limitations and substantially increase an SMSF borrowing capacity:

The property

An average property in Australia might have a 4% per year gross rental return and by definition, most of our clients would initially fall within that average range. While a property with such a rental return could very well be a terrific investment because of its capital growth prospect, it may not be ideal for an SMSF as it may not service well.

Some of our clients are purchasing very attractive investment properties with a rental return of above 5% per year gross rental return and while a 1% difference may not sound like much, on the $400,000 property above, that would be $4,000. Going from a $1,900 to a $5,900 buffer is a huge difference and it would have a really big impact on how much this SMSF can borrow.

Hybrid lending – Increase the deposit

If your SMSF’s deposit is not enough for the property which you would like it to purchase and depending on your circumstances, you might be able to boost your deposit by lending all or some of it to your SMSF.

If you have cash or equity in your personal capacity, you could lend some of it to your SMSF hence boosting its own deposit. This SMSF lending strategy would, in turn, boost the SMSF’s purchasing capacity.

Salary Sacrifice – Increase the Income

When our clients have a comfortable cash flow personally and they want to increase their SMSF borrowing capacity, we generally recommend that they speak to a financial adviser about the suitability and possible tax benefits of salary sacrificing.

Salary sacrificing is essentially asking your employer to pay some of your wage to your superannuation fund. These additional contributions are therefore not taxed at the top marginal tax rate but at the much lower superannuation tax rate.

Aside from potentially reducing the tax payable on that income, it increases the funds available to the SMSF to make repayments on its loan which in turn will allow the banks to lend more to this SMSF.

Lenders have vastly differing requirements when it comes to using salary sacrifice for servicing purpose. Some of them will require a long history of salary sacrificing before using it for their calculations while others will be satisfied with much less evidence of it.

If you are looking at maximising your SMSF borrowing capacity, contact SMSF Loan Experts on 1300 781 680 or visit our website www.smsfloanexperts.com.au

* The information contained in this blog is general information only. No part of this blog is to be construed as a solicitation to buy or sell any security or financial product. The author, in preparing this blog, did not take into account the investment objectives, financial situation and particular needs of any particular person. Before acting on any information or advice in this document, you should consider the appropriateness of it (and any relevant product) having regard to your circumstances. You should also seek independent financial advice prior to acquiring a financial product.