Note, this is a guide containing general information only. Please seek personalised professional advice from a qualified advisor before making significant financial decisions.
How do self-managed super fund loans work?
An SMSF loan lets you use your self-managed super fund to buy an investment property. Instead of using a standard home loan, you can borrow money through your super fund to purchase residential or commercial property.
Although SMSF loans open the door to a property investment strategy for those saving for retirement, they come with strict regulations that can be tricky to navigate.
These types of loans are available through specialist lenders who understand the unique requirements of SMSFs.
Here’s an overview of how SMSF loans work:
SMSF loan structure
A separate “bare trust” is set up to hold the property on behalf of the SMSF. This trust is often managed by a corporate trustee. The SMSF takes out a loan from a lender, using the property as security.
Property purchase
The SMSF borrows money to buy the investment property, which is held in a separate trust specifically set up for this purpose. The SMSF typically covers the deposit and ongoing expenses, while the loan finances the remaining cost. The property’s rental income and any capital gains go back into the SMSF, helping to grow your retirement savings.
Loan terms
SMSF loans are usually set up as Limited Recourse Borrowing Arrangements (LRBAs). This means that if there is a default on the loan, the lender can only claim the property purchased with the loan, not other assets of the super fund.
Repayments
Repayments are made by the super fund and typically include both principal and interest payments. Rental income from the investment property is deposited back into the SMSF, helping cover the loan repayments and fund expenses, while also increasing your super balance.
Getting professional financial and tax advice is crucial for SMSF loans because they come with complex rules and tax implications that can affect your retirement savings. Seeking expert advice can help you stay compliant and make the most of your superannuation investments.
SMSF sector overview
- There are over 1.1 million SMSF members, according to the latest ATO data.
- Over two-thirds of SMSFs (68.3%) have two members (trustees), while 24.8% have one.
- More than three quarters of SMSF members (78.1%) are over 50 years of age.
- On average, each SMSF has about $1.45 million in assets, or roughly $780,000 per member.
Rules and considerations around SMSF loans
There are several rules and considerations around SMSF loans, as explained by Mark Chapman, Director of Tax Communication at H&R Block:
1
As a member of an SMSF, you cannot live in the residential property. This rule also extends to other trustees or anyone related to the trustees, no matter how distant the relationship.
2
It cannot be rented by you, any other trustee or anyone related to the trustees, so buying a holiday home in your SMSF and living there during the summer isn’t allowed.
3
The property must not be acquired from a related party of a member, even at market value.
4
Borrowing to buy property through an SMSF is achieved by way of a limited recourse loan. This means that the borrowing is made through a trust (often called a Bare Trust), which has the legal title in the property.
5
Beneficial ownership rests with the SMSF, which then collects all of the rental income on the property. The reason for this arrangement is so that the lender can take charge of the property if the SMSF fails to keep up with the loan.
6
In addition to the establishment of an SMSF and its trustee, an additional trust (bare trust) and trustee (which cannot be the same as that of the SMSF) must be legally established to enable the super fund to borrow and purchase the property.
7
Borrowing criteria for an SMSF are generally much stricter than for a normal property loan which you might take out as an individual and come with higher costs, which need to be taken into account when working out if the investment is worthwhile.
8
It is strongly recommended that you approach a financial institution prior to incurring the costs of establishing an SMSF and the other legal entities required to get an idea of how much they are willing to lend you based on your current super balance and anything you may be willing to contribute personally to the investment.
Mark Chapman, Director of Tax Communication at H&R Block
“Remember that loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan requirements. The SMSF can fund the loan repayments through rental income on the property and through superannuation contributions into the fund.”
Mark Chapman, Director of Tax Communication at H&R Block
How much can you borrow with an SMSF loan?
You can generally borrow up to 70-80% of the property’s value, but you can’t use your entire SMSF balance for a deposit. This means you’ll need at least $100,000-$200,000 in your fund.
- Let’s imagine you’re looking to purchase a property valued at $600,000.
- Your lender requires a liquidity buffer of 10% and a maximum LVR of 80%.
- This means you’d need to have $60,000 leftover in your SMSF as a liquidity buffer.
- You’d also need $120,000 for the deposit to reach an LVR of 80%.
- Therefore, in this scenario you’d need a minimum of $180,000 in your SMSF.
If you have a sufficiently large SMSF balance and meet the lender’s criteria, you can usually borrow up to $2,000,000 for residential properties and up to $10,000,000 for commercial properties.
Keep in mind that some lenders may not have a liquidity buffer, while others may require you to have at least 5 or 10% of the investment property’s value left in your SMSF once all the fees and charges have been deducted. Essentially, you'll need to make sure you have enough cash flow remaining to meet a portion of your loan repayments and for expenses like rates and body corporate fees.
Here are the main factors that’ll impact your borrowing power:
- How much money is in your SMSF
- The value of the investment property
- The property’s rental income and its ability to cover loan repayments
- How much you make in annual contributions to your SMSF
- Whether the trustees of the SMSF have a good credit history
Mansour Soltani , Money's Home Loans Expert
“You’ll generally need to have a liquidity buffer of 5 to 10% remaining in your SMSF, but the amount will vary based on the lender. The liquidity buffer and your loan-to-value ratio will have the biggest impact on the interest rate you’re offered. Other factors include the rental income of the property and your super contributions.”
Mansour Soltani , Money's Home Loans Expert
Key tax implications for SMSF loans
If you buy a property through an SMSF, the fund will pay 15% tax on the rental income from the property.
On properties held for longer than 12 months, the fund receives a one-third discount on any capital gain it makes upon sale, bringing any CGT liability down to 10%.
If the property is purchased via a loan, the interest payments on the mortgage are tax deductible to the super fund.
If expenses exceed income there is a taxable loss that is carried forward each year and can be offset against future taxable income.
Once fund members start receiving a pension at retirement, any rental income or capital gains arising in the fund will be tax free.
“Note also, that if you make a loss on your property rental, any tax losses cannot be offset against your personal taxable income outside the fund.”
SMSF loan pros and cons
Pros
- Allows you to use your self-managed super fund to invest in property
- Rental income and capital gains are directed back into your super fund, potentially increasing your retirement savings
- Earnings from property investments within the SMSF may benefit from favourable tax treatment
- Other assets separate to the property in the SMSF are protected from creditors in the event you can't repay the loan
Cons
- Often comes with higher mortgage interest rates compared to regular investment property loans
- Managing SMSF loans involves navigating complex legal and regulatory requirements (you’ll need to seek professional financial or tax advice)
- Relatively few lenders offer SMSF loans, which can limit your borrowing choices
- There may be significant upfront costs, including establishment, risk and legal fees
Myths and misconceptions about SMSF loans
It is possible to use a loan to acquire any form of investment in your SMSF, including listed company shares and property. The most common, however, is property. There are a number of do’s and don’ts for investing in assets through your SMSF:
Mark Chapman, Director of Tax Communication at H&R Block
“The asset must meet the ‘sole purpose test’ of solely providing retirement benefits to fund members. There can be substantial fees and charges associated with the purchase, ownership and subsequent sale of a property in an SMSF. These will eat into your super balance so you need to ensure the income into the super fund will cover these costs and allow for growth. Many people assume that if they contribute personal monies into the purchase, that once the super fund has the money, they can repay themselves. This is not the case. You may contribute your own money to help purchase the property, but that will be counted as contributions and can’t be withdrawn until you meet preservation age and a condition of release (for example, retirement)."
Mark Chapman, Director of Tax Communication at H&R Block
The costs include:
- Upfront fees
- Legal fees
- Advice fees
- Stamp duty
- Ongoing property management fees
- Bank fees
The CEO of the SMSF Association, Peter Burgess, also clarified some common myths surrounding SMSF loans:
Peter Burgess, Chief Executive Officer of the SMSF Association
"Probably the biggest misconception relates to the release of equity. Investors often mistakenly believe they can use the equity from a property acquired using an SMSF loan to build a multiple property portfolio in the same way they can outside of super. Another common misconception relates to renovations and improvements. Many people are often unaware that they are not able to draw-down from the loan to finance property improvements. The SMSF can only use its own funds for such purposes. They are often also unaware that the improvement or renovation cannot fundamentally change the character or use of the property. For example, a major refurbishment that changes the nature and use of the property from residential to commercial, is not permitted."
Peter Burgess, Chief Executive Officer of the SMSF Association
What documents do you need for an SMSF loan?
You’ll generally need to provide the following documents when applying for an SMSF loan:
- Certified copy of the SMSF Trust Deed
- Certified copy of the Custodian Trust Deed
- Audited financial statements for your SMSF
- Minimum 6 months of bank statements for your SMSF
- Most recent SMSF tax return
- Estimates of rental income
- A full copy of the contract of sale
- Any previous independent legal advice
- Proof of identity (i.e. driver’s licence, copy of passport)
SMSF loans: How to apply
To apply for an SMSF loan, you should start by seeking professional financial and taxation advice. This can help you understand the requirements and ensure your SMSF is set up correctly. These experts can guide you through the process, including setting up a separate trust to hold the property, assessing your liquidity buffer, and determining the best loan terms for your situation.
Once you’ve sought professional advice, you can usually apply for an SMSF loan online through your chosen lender or by using a mortgage broker. Here’s a step-by-step overview of how the application process works:
1
Get pre-approval
Before making any offers, get pre-approval for your SMSF loan. This helps you know how much you can borrow and gives you a clearer idea of your budget.
2
Set up a bare trust
Once pre-approved, set up a bare trust deed. This trust holds the property on behalf of your SMSF. It’s important that the bare trustee is not a member of the SMSF, and often a corporate trust is used.
3
Finalise the purchase contract
After negotiating with the seller, your SMSF will need to pay the deposit. Ensure the contract is in the name of the bare trustee, not your SMSF directly.
4
Obtain formal loan approval
The lender will arrange for a property valuation. Once the valuation is complete and the purchase contract signed, the lender will issue formal loan approval.
5
Complete the mortgage documentation
The lender will prepare mortgage documents with specific provisions for SMSF property purchases. Review and sign these documents to finalise the loan.
6
Settle the purchase
At settlement, the purchase is finalised. The lender will hold the transaction and title documents. Your SMSF can then take ownership of the property.
