Talking about and actually purchasing property is a national past time in Australia, and a self-managed superannuation fund (SMSF) can be an excellent vehicle to do this. It could be a great way to purchase your first investment property, or a tool for you to expand an existing portfolio.
There are some key differences when purchasing (and more importantly financing) property in an SMSF that you need to be aware of, compared with buying property outside of super.
Borrowing costs can be higher
Due to tightening of lending requirements in Australia, borrowing through an SMSF is more expensive than outside of super, that is, you’ll be charged a higher interest rate. This is generally the headline variable rates the bank is offering, before all the snazzy discounts are applied to make it more competitive. Theory is, better to slap the SMSFs with this, than the first home buyers – which is probably pretty fair!
You can’t use the entire value of your fund
Unless you’re planning to pay for the property outright, and you can avoid talking to the bank at all, you’ll need to play by the bank’s rules. They’ll generally want a minimum of 10% of your fund to stay in cash, to ensure you’ve got the elbow room required to meet your future mortgage repayments. When working out what you can afford to spend on property, you’ll need to factor this in, and remember you’ll also be paying stamp duties on the property.
You can’t borrow as much
Within your SMSF, you need to have a loan-to-value (LVR) ratio of 70% as a maximum. This is very different to outside of super where you can borrow up to 90% (often even 95%) just by forking out for Lenders Mortgage Insurance (LMI) to cover the bank in the case of you defaulting. LMI is not the issue here, it’s the banks being conservative. Get it under 70%, or don’t get the financing. This can be a great element, because it means you’re going to be borrowing less.
Your loan needs to be principal and interest
Many investment properties held outside of super are structured to pay interest only on the loan, that is, to only make the interest payments and not reduce the loan balance at all. That strategy is very much linked to negative gearing and tax effectiveness. It’s a whole other kettle of fish within super. Your financing must be set up as principal and interest loan, meaning that over the term of the loan, your balance will be working its way down to zero. This means your repayments will likely be higher than if you bought the property outside of super, but after the loan term is finished, you’ll have an unencumbered property – all asset, no debt.
Your loan term is just 15 years
Within super, you can have maximum loan term of 15 years, compared with traditional mortgages of between 25 and 30 years. Again, this will make your repayments higher than if you chose a longer term outside of super, but it means you’ll be done and dusted a lot faster! You’ll also likely pay a lot less interest over the life of the loan.
The terminology is different
We’ve referred above to a “loan” for simplicity, or a “mortgage”. In reality the way you borrow money within your SMSF is through a Limited Recourse Borrowing Arrangement (LRBA) – what a mouthful! Chat to your adviser or accountant to understand more about what this really means for you, and how it is established.
There are also some restrictions on the property itself you also need to be mindful of. We highly recommend engaging a property lawyer to be speaking with your SMSF adviser and accountant about whether the property you’re looking at legally meets the criteria.
Ready to take control of your super and start putting it to good use? Let’s talk.
Disclaimer: all information contained within this article is of a general nature and should not be relied upon when making financial decisions. Please consult a professional financial advisor or planner (like us!) before acting.