While many feared that the exodus of major banks from the SMSF loans space would spell the end of SMSF borrowing, the volume of SMSF loans remains steady, with many non-bank lenders filling the gap. We take a look at the ins and outs of SMSF lending.
The SMSF lending landscape has transformed considerably over the past five years with all of the major banks exiting the space and the introduction of new regulations impacting certain types of these loans. This hasn’t dampened the appeal of these SMSF borrowing, however, with limited recourse borrowing arrangements (LRBAs) accounting for around 7 per cent of the total assets held by SMSFs.
The ATO’s latest SMSF quarterly statistical report estimates that the total value of LRBAs now sits at around $47.3 billion. This represents an 8.2 per cent jump in the 12 months to March this year. While the major banks have lost their appetite for SMSF loans, non-bank lenders, on the other hand, have increased their activity in this space.
Unique features of SMSF loans
LRBAs are most commonly used by SMSF members for acquiring residential or commercial real property, where they don’t have sufficient capital in their fund. They can, however, be used to purchase shares or even managed funds in some cases. In order for an SMSF to borrow money, the arrangement needs to satisfy a number of important conditions, otherwise it will be in breach of the superannuation laws.
One of the key legal requirements for LRBA investments is that the asset being acquired must be held on trust by a bare trustee on behalf of the SMSF. It is also critical for SMSF members to ensure that an LRBA is consistent with the investment strategy of their fund before entering the arrangement. Super fund trustees cannot borrow to improve an asset, and the borrowing must be limited to a single asset or a collection of identical assets that have the same market value. Where the loan defaults, the lender’s rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF.
What brokers need to know
Thinktank director Per Amundsen says most lenders require brokers to complete specific training, either with them or through an accredited external provider to ensure that they have the necessary knowledge and competence in what is a highly regulated and compliance-dominated product and process.
Mr Amundsen says this requirement can be waived where relevant formal qualifications are already held.
“Engaging directly with an experienced lender can be especially valuable when getting started, as there is a lot that can be communicated quickly, which can smooth the process for the benefit of all the parties involved. Often, lenders may have small things they do differently,” he explains.
“SMSF LRBA loan applications are more involved than standard residential and commercial loans, and there are several key steps and documentation requirements that must be adhered to. Becoming familiar with what lenders require and having an experienced relationship manager in support is a strong recommendation,” says Mr Amundsen.
For brokers wanting to offer these types of loans, Mortgage Ezy general manager of operations Joanna James recommends that brokers work on building partnerships with SMSF specialists in their area, including local advisers and accountants. It is important to create a synergy between the different professions, she says.
She also warns brokers to only offer loan advice under the requirements of the National Consumer Credit Protection Act.
“Leave the accountancy or legal advice to the appropriately licensed adviser of the SMSF structure,” she cautions.
Rocco Massaria, managing director or Your Manager, says that many lenders, including his own, offer accredited training programs and support for brokers, as well as marketing materials that can be used to help generate referral sources from accountants and advisers.
What SMSF loan products are available?
There has been a big shift in the types of lenders operating in the SMSF loans space in recent years, with none of the major lenders now offering SMSF loan products for residential property.
Macquarie was the last of the five largest lenders to pull out of SMSF lending. This followed similar moves by Westpac, AMP, Commonwealth Bank and National Australia Bank. Bank of Queensland is one of the smaller banks still providing SMSF loan products for residential property.
While the larger lenders may have exited SMSF property loans, many of the non-bank lenders are now filling the gap. My Mortgage Freedom broker and associate director Sean Murphy says lenders like Liberty and La Trobe Financial still remain very active in the SMSF space. In addition, new lenders are entering this niche market with comprehensive solutions.
“They are actually paying attention to what the market needs and presenting great products,” says Mr Murphy.
Indeed, Ms James explains that the majors lost their appetite in this space because SMSF loans didn’t meet their criteria in terms of automation and credit score modelling.
“Banks did not have the specialty staff required to assess deals individually, and as the amount of SMSF loans was not a major contributor to their overall volume, they made a commercial decision to pull back from this market,” she says.
Non-bank lenders such as Mortgage Ezy, however, don’t have the same volume requirements as the majors, as they don’t follow a cookie-cutter approach.
“More nimble non-banking businesses are geared up to individually assess files and are able to provide the service levels required,” says Ms James.
“SMSF [loans] are generally a low loan-to-value ratio, low-risk product – both in terms of arrears and performance – which fits into our model that supports brokers [in] having a variety of products on hand to enable the growth of their businesses.”
SMSF loans for commercial property
Thinktank is one of the more recent non-bank lenders to enter the SMSF loans space. Mr Amundsen says the commercial finance lender is seeing continued increase in demand for its SMSF loan products, as members search for more attractive investment options.
Out of the two main loan products available for SMSFs, LRBAs for commercial property have tended to dominate the statistics to date, according to him. These loans are suited to the circumstances of business owners who can align their long-term wealth management and retirement plans with running their business from a commercial property, which in turn pays rent back to their own SMSF.
“It is also active territory for experienced property investors because the long-term tax advantages of holding property in an SMSF can be significant,” he explains.
“Residential property LRBA loans can also form part of a good long-term wealth strategy, subject to informed financial and legal advice. While commercial LRBAs tend to be associated with those who are self-employed, including a lot of brokers, residential LRBAs are more frequently sought by PAYGs who want to buy and hold investment property for the longer term with a view to eventual retirement income and tax-effective assets.”
Both products, he says, are readily accessible by brokers and their clients through a number of non-bank lenders present on aggregator panels.
Regulation boosting commercial market
One of the other factors that have led to a renewed interest in SMSF loan products by commercial lenders is the rising complexity with related party loans. Related party loans (where the money for the loan is often provided by the member themselves) have been a popular option for some SMSFs in the past. However, there has been a series of regulatory and legislative changes impacting these loans.
Pitcher Partners managing partner Michael Minter has seen a reduction in related party borrowing due to tighter restrictions around how these loans operate.
These loans need to comply with certain terms set out by the ATO, referred to as “safe harbour parameters”.
“If you choose to borrow from a related party, then you must prove to the ATO that the arrangement with the related party was on the same commercial terms that you would have got with an unrelated party. It is not on ‘arm’s length’ terms if the bank would never have lent you the money in the first place,” Mr Minter explains.
The SMSF either needs to match the terms of the loan to the safe harbour parameters set by the ATO (which specify certain interest rates, maximum loan term and how payments need to be made) or match the loan conditions to that of commercial loan products available in the market. If the SMSF cannot prove the loan is on commercial terms, then this may give rise to additional taxes from what’s known as non-arm’s length income.
In addition to tighter restrictions with the operation of these loans, the government has also introduced a measure that impacts a member’s total superannuation balance (TSB) where they are in retirement or have a related party loan. The legislative amendment means that the outstanding balance of an LRBA is included in a member’s TSB. Where the TSB exceeds a certain amount, this can restrict a member’s ability to make certain contributions to their fund.
Australian Executor Trustees senior technical services manager Julie Steed says changes to the way related party LRBAs were factored into trustees’ TSB, effective as of 1 July 2018, could drive more SMSFs back into sourcing their property loans from an external third party.
Providing assistance to clients around SMSF lending has become an increasingly complex area for advisers, she says, who are often unfamiliar with non-bank lenders in the space or unable to recommend them due to dealer group or panel restrictions.
“Advisers may need to develop a relationship and familiarity with some of the newer types of products, particularly if they’ve got clients who have got related party loans that they are going to want to get out of because of the impact it is going to have on their TSB and their ability to make non-concessional contributions,” she explains.
One of the other developments on the regulatory front is a new instrument from the ATO that allows LRBAs to be structured in a slightly different way. While some commentators have argued that the change will make it easier to get bank approval for these loans, lenders are still unsure what it means for their products at this stage.
Mr Amundsen says the intermediary LRBA Determination by the ATO appears to do two things.
“Firstly, with its effective commencement date slated as back in September 2007, it serves to potentially transform what may have been non-conforming LRBAs, which might not have been established in a correct technical manner into conforming structures without penalty or placing the fund to additional cost,” he explains.
“Secondly, there is prospect in the nature of these new rules for lenders to adapt their LRBA products and requirements to facilitate funding on a slightly varied basis. We are currently considering what this may mean in terms of product development that is consistent with the intent of the ATO, which is not abundantly clear at this time. We expect anything new will be incrementally evolutionary rather than revolutionary.”
The impact of COVID-19 on SMSF loans
Similar to the broader home loan market, some SMSFs have been impacted by COVID-19 relief requests for rent reductions and rent waivers from tenants in SMSF-owned properties. The type of loan relief being offered by lenders in this space is in line with the loan relief policies announced by the Australian Banking Association.
Smarter SMSF chief executive Aaron Dunn says banks have agreed to provide temporary deferrals for most borrowers impacted by COVID up to six months, with unpaid interest being capitalised on the loan.
With parts of Australia, such as Melbourne, still working through the challenges of reopening its economy due to COVID-19 – and the six-month loan repayment deferral period fast approaching – many banks have implemented a new phase of support to help get their customers back to making repayments.
“For those still struggling due to reduced incomes and ongoing financial difficulties due to COVID-19, these people will be contacted towards the end of the deferral period to ensure that, wherever possible, they can return to repayments through a restructure or variation to their loan,” Mr Dunn explains.
“If these arrangements are not in place at the end of the six-month deferral, customers will be eligible for an extension for up to four months. This period will allow for the customer to work with their bank to find the best solution for them.”
The comeback kid
Despite the recent downturn in property prices resulting from COVID-19, Mr Massaria says there has been a comeback for SMSF loan products with clients looking for opportunities with lower property prices. Commercial SMSF lending in particular has “definitely picked up”, he says.
“With many majors no longer offering SMSF loans and locking in clients at high rates, brokers are looking to save clients’ money with the lower rates and features,” he explains.
Ms James agrees that SMSF loans “have stood firm in these more uncertain times”.
“Monthly volume is estimated at more than $3 billion at present. It is a resilient method of lending as it has the ability to service on the super fund alone, without needing to consider individual expenditure or other personal liabilities or loan arrangements,” Ms James explains.
“Like anything, COVID-19 has brought unprecedented uncertainty, and no one can say for sure that SMSF lending is immune. However, its robust and diverse nature indicates that it has the ability to weather the storm.”
Beyond the general adjustment that all lending has needed to make with new ways of looking at VOI, valuations and mortgage documentation, the demand, she says, has remained strong.
Both Mortgage Ezy and Thinktank have seen a consistent increase in demand for SMSF loan products, according to the two heads.
The volatility and increased uncertainty attached to equities in the current climate and the low yields on bonds and term deposits could be leading some SMSFs to consider other asset classes, including property, Thinktank’s Mr Amundsen says.
Future of the space
Mr Amundsen says that while LRBAs may not see spectacular growth over the coming years, he expects that demand in this product segment will remain steady.
He warns that SMSF loans are still on the radar of regulators and politicians who harbour concerns over potentially conflicted or inappropriate promotion and latent risks to both fund members and rapid growth distorting the property market.
“Yet the high-quality performance of LRBA loans over an extended period now has served to quell many of these concerns,” he says.
“In brief, it remains an area of significant activity and opportunity for brokers and their clients in both commercial and residential property.”
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