Should you invest your super in property with borrowings?

In 2007, laws changed to allow SMSFs to borrow for property investments if they met specific compliance rules.

This led to a surge in super-funded property investments from 2007 to 2017, totalling around $45 billion.

However, major banks withdrew SMSF borrowing products between 2017 and 2018 and super contribution rules were tightened, making this strategy less popular over the past 5-6 years.

Recently, smaller lenders have introduced new SMSF lending options with favourable terms and interest rates.

This development has prompted my interest in assessing the benefits of this strategy.

What is involved in using your super to borrow to invest in property?

Normally, SMSFs are not allowed to borrow money for the sole purpose of testing.

However, in 2007, the Howard government introduced an exemption to this general prohibition (Section 67 (4A) of the SIS Act).

This allowed SMSFs to borrow if they met specific compliance criteria:

  • The property under mortgage must be held in a separate bare trust to protect other SMSF assets.
  • The loan should be a limited recourse borrowing arrangement, meaning the lender can only sell the property to recover the loan, not access other SMSF assets or members’ funds for any shortfall.

Compliance with these rules is complex.

For instance, SMSFs should avoid properties with multiple titles (common with apartments) and be cautious about making significant property improvements.

Therefore, seeking professional advice on these matters is essential.

Why did SMSF borrowing become less popular?

The decline in popularity of borrowing to invest in property through superannuation can be attributed to two key events.

Firstly, in 2007, when SMSFs were first able to borrow, the concessional cap was very generous at $50,000 p.a., or $100,000 p.a. for individuals over 50.

The concessional cap is the maximum amount you can contribute to your superannuation, whilst being able to claim a tax deduction.

This higher cap allowed individuals to make substantial contributions to support property investments and enjoy the same tax advantages as negative gearing.

However, on 1 July 2009, this cap was halved to $25,000 for individuals under 50 (and for individuals over 50 on 1 July 2012).

This reduction in the concessional cap limited the monies available for superannuation to finance property investments, effectively decreasing the borrowing capacity of SMSFs.

Secondly, due to increased regulatory scrutiny by the Australian Prudential Regulation Authority (APRA) on investment and interest-only lending, many lenders began withdrawing SMSF lending products from the market in 2017 and 2018.

SMSF lending only represented a small fraction, approximately 1%, of the total mortgages in Australia, making it less appealing to major banks.

Additionally, these loans typically had smaller average sizes and involved more administrative work.


Resurgence of SMSF lending

In recent years, several smaller lenders have introduced new SMSF lending products.

Key features of these products include:

  • Borrowing up to 90% of a property’s value in metropolitan areas, with a maximum loan limit of $1.35 million.
  • When assessing the SMSFs’ borrowing capacity, these lenders take into account 80% of gross prospective rental income, the average investment income from the past 24 months, mandatory super contributions, and voluntary contributions with a consistent history of two or more years.
  • The current variable interest rates are around 7.30% p.a., which is roughly 2% lower than the interest rates associated with legacy loans from major banks.

In summary, these new products offer more generous borrowing limits at lower interest rates when compared to the products previously offered by larger banks.

Refinancing existing bank loans

The major banks have never provided discounts on their standard variable rates for SMSF loans, unlike the concessions offered for regular home and investment loans.

Consequently, most SMSF borrowers currently find themselves paying interest rates exceeding 9% p.a., especially if their loans have been in place for more than a few years.

As a result, an opportunity exists to refinance existing SMSF loans to these emerging lenders, often saving more than 2% per annum on interest.

However, it’s crucial to approach loan refinancing carefully. It’s worth noting that many of these smaller lenders are not Approved Deposit Institutions (ADIs), and therefore, I wouldn’t recommend maintaining substantial cash balances in offset accounts (if applicable), as these deposits are not guaranteed by the government.

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