Changes to APRA standards have moved the goal posts for SMSFs borrowing to buy real estate. The problem is we’re late in the second half.
Acquiring property through a SMSF using borrowed money may be an attractive investment choice for many, however, with banks tightening their lending criteria on the insistence of The Australian Prudential Regulation Authority (APRA) to curb investor borrowing, trustee/s need to ensure that the SMSF has sufficient funds to settle where an off-the-plan property has been purchased.
With APRA’s new measures being in force, banks are now requiring SMSFs to have at least 40% of the value of the property as a deposit in addition to the higher interest rates that banks are now charging. On top of this many lenders are not approving finance for a fund that does not have at least $200,000 initially, and sufficient liquidity in the fund after the property has been purchased.
So what does this means for trustees who have thought they could borrow money to purchase an off-the-plan property? For starters one of the risks of purchasing with a mortgage is that if the lender’s final valuation comes in lower than the contracted price, trustees may be forced to make up the shortfall from the SMSF’s own funds, which could be an issue if the SMSF does not have sufficient funds.
Trustees who may be contemplating purchasing off-the-plan should consider the liquidity of the fund to manage lower valuation or the demand for a lower loan-to-valuation ratio from the lender (from 80 percent to 70 per cent).
Trustees should also consider whether they have the capacity and ability to add funds to the SMSF without breaching the contribution caps.
Trustees may also wish to consider taking out a loan from a related party (i.e. a loan from a member of the SMSF) where the fund needs to make up the shortfall of the purchase price on settlement. Legislative requirements require this type of loan to be at arm’s length which will require security such as a mortgage over real property registered with the relevant State’s land titles office.
It may also be necessary to consider whether there is a loan agreement in place already, in which case does the agreement allow for the terms to be varied?
Section 109 of the Superannuation Industry (Supervision) Act 1993 requires related parties to deal at arm’s length with each other. Would a commercial lender such as a bank allow the terms of the loan to be varied by trustee/s minutes? What terms should be inserted? Will you go with the so-called ‘safe harbour’ terms or do you have evidence of more advantageous terms in the market that the fund can make use of?
As the loan terms must apply for the whole year, does the fund have enough money to pay additional interest for that period?
Also whether the trustee/s need:
to understand their obligations more completely
to document and confirm a previous loan
to vary the terms of a current loan
to have a mortgage prepared
to get help implementing any of the changes or new documents including registering a loan variation.
Borrowing by SMSFs is under attack (Part 2)
New measures could make SMSF borrowing more problematic. Do you need to act now?
The Government is proposing the introduction of new measures that will impact all Limited Recourse Borrowing Arrangements (LRBA), entered into on or after 1 July 2018.
These measures, if enacted, will include a member’s share of any outstanding LRBA debt in the calculation of their total superannuation balance, which may have a flow-on effect on that member’s ability to make contributions, including catch-up contributions.
While these measures may be modified or even not enacted, clients who are currently considering entering into an LRBA may see the benefit of making the jump and, ideally settle, before 30 June 2018, to minimise the risk of being caught.
Matters will be a little more complicated for off the plan purchases – as there is no drawdown of the loan until the property is close to completion – which may be in one or two years’ time.
While at the moment there is no exception available for this type of transaction, the consultation paper does raise the possibility of transitional rules for LRBAs which straddle 1 July 2018.
… More to come once the legislation has been enacted during the Budget session next month.
By Elizabeth Wang
3 May 2018
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