How Do Super Loans Differ from Traditional Property Financing?
A Super Loan might look just like a regular home loan at first: you get the cash, buy a place, and pay it back. But the way it actually works behind the scenes is pretty different. When you tap into your super to invest in real estate, the whole mortgage game changes significantly compared to financing your own family home.
Understanding Limited Recourse Borrowing Arrangements (LRBA)
The greatest disparity is in the name: Limited Recourse.
In the case of a regular home loan, the bank is fully recourse. This implies that in case of a failure and you are unable to make your mortgage payments, the bank will be able to sell your house. When the sale is not sufficient to pay what you owe, they may pursue your other property–your car or your savings or even your wages.
A Super Loan offers you a safety net on your retirement savings.
The bank is restricted to only taking that particular property in case your Self-Managed Super Fund (SMSF) is unable to settle the loan. They are not allowed to touch the other investments in your super fund.
Think of it like this:
In case your super fund has a rental property worth $800,000 and share market investment of $500,000, the bank can only seize the rental property. Your $500,000 in shares stays safe. This regulation shields your pension fund against being swept away by a single bad real estate deal.
Comparing SMSF Loan Interest Rates and Setup Costs
The more risk the bank takes the higher they charge you.
The interest rate on an SMSF mortgage will generally be higher than on a typical home loan, typically by 1-1.5 percent.
It is not only the interest rate, either. Setting this is costly compared to visiting a bank to take a regular loan. You cannot simply purchase the property under the name of the fund when it has a loan attached to it. You need to establish a special trust (commonly referred to as a Bare Trust) to store the title to the property until the loan is repaid.
This means you are paying for:
- Establishment fees: The establishment of the Bare Trust and Corporate Trustee.
- Legal expenses: Legal expenses increase with the increase in paperwork.
- Application fees: These tend to be more expensive in the case of commercial products or SMSF.
You must do the calculations to ensure that the rental income is going to meet these additional expenses.
ATO Rules on Property Renovations and Improvements
This is one of the pitfalls that most individuals get into.
In the case of a normal investment property you may purchase a fixer-upper, borrow some additional money, and install a brand-new kitchen to rent at a higher price.
You cannot generally do this with a Super Loan.
According to the rules, borrowed money may be used to fix a property (such as a broken window or a leaking roof), but it may not be used to enhance it.
- Permitted: Replacement of a broken toilet.
- Not Permitted: A second story addition, granny flat, or gutted out functioning kitchen with the idea of making it contemporary.
In case you want to upgrade the property, you need cash in your super fund and not the loan money. And you can certainly not alter the character of the property, for example a residential house into a dentist office–until the loan is paid off.
Deposit Requirements and Lending Criteria for Super Loans
You will not be able to afford a house on a 5 percent deposit as you would with your first house.
Banks would like to know that you are financially secure. The majority of lenders will require a deposit of 20 to 30 percent. They may even demand more in the case of a commercial property purchase.
The bank also examines your capacity to pay in a different manner. In the case of a normal loan, they consider your salary. For a Super Loan, they look at:
- Rental income: What the property will bring.
- Super contributions: The amount that your employer invests in your fund.
They are not normally going to consider your personal disposable income since that money is not legally available to settle your super debt.
Seeking Professional Advice for SMSF Property Investment
The government made these rules really strict on purpose. It’s to stop people from taking unnecessary chances with their retirement money.
A single misstep such as signing the contract under the wrong name can make the loan fail or result in huge tax fines.
You need a team on your side. In many cases, it is better to seek local professionals that you can meet personally. For example, looking for experienced tax agents nowra can be a game-changer when you live in the Shoalhaven area. They could assist in making sure that your audits and tax returns are as clean as a whistle and you are left to concentrate on the investment itself.
Summary of Super Loans vs. Regular Mortgages
It is a wonderful idea to borrow in your super to multiply your wealth but it is not a set and forget strategy.
- Pros: Your other super assets are secure in the case of default of the loan.
- Cons: Higher rates of interest, larger deposits and rigid regulations on renovations.
Don’t leap in before you realize that it is not another home loan. It is a technical financial instrument and has extremely narrow rules. Calculate, take good advice and ensure it is the correct step towards your retirement.
