SMSF: can loans help fund your retirement?
Most of us are familiar with home loans. But when dealing with SMSF – or self managed super funds – the rules around borrowing money to buy property are very different.
SMSF Survival Centre founder Max Newnham says there are tight regulations and restrictions around a super fund borrowing to fund a property purchase.
There are tight regulations around a super fund borrowing to fund property.
“This in many cases results in the costs of borrowing being high and also in some cases a higher interest rate being paid,” Newnham says.
Read more: SMSF & borrowing to fund investment strategy
Home loans vs SMSF loans
One of the key differences between home loans and SMSF loans is the type of loan involved.
If the trustees of an SMSF want to take out a loan to buy property, they must use what is called “limited recourse borrowing”.
Limited recourse borrowing
This means that the bank lending the money can take as security only the property being purchased and not any other assets of the funds.
“In some cases financial institutions have regarded a non-recourse loan as being more risky and therefore higher interest rates are applied,” Newnham says.
On top of this, a trust must be set up to hold the property the SMSF is buying.
“The property remains in that trust name until all of the borrowings have been repaid,” Newnham says.
A trust must be set up to hold the property the SMSF is buying.
“This adds an extra layer of costs to the purchase and also to the ongoing accounting for the super fund compared to ongoing costs if the property is purchased by an individual.”
Read more: SMSF: Another way of saving for retirement
The Australian Securities and Investments Commission also warns there can be risks with borrowing to fund SMSF property investments. These include:
- Higher costs. SMSF property loans are usually more expensive than other property loans.
- Cash flow. Repayments must be made from your SMSF, so your fund needs to have enough cash flow to cover them.
- Hard to cancel. If your loan documents and contract are not set up properly, unwinding the arrangement may be difficult and you may have to sell the property.
- Possible tax losses. Tax losses cannot be offset against your taxable income outside the fund.
The ATO also warns it is vital to understand how limited recourse borrowing works before making any investment decisions.