SMSF or self-managed super funds are becoming increasingly popular, owing to better SMSF products from banks and non-banks. More importantly, this lending type has the lowest default rates compared to other loan instruments. However, it’s still somewhat complicated to understand and difficult to manage.
Employees and business owners are using loans against their superannuation to invest in residential and commercial properties. Thanks to increased rents across Australia, there’s a renewed interest in real estate investment, and SMSF lending presents a unique opportunity.
In this article, we’ll discuss what an SMSF loan is, how it works, and why it’s becoming a popular option for Australians looking to invest in properties.
What is an SMSF Loan?
A self-managed super fund (SMSF) is a fund commonly used to save for retirement. Unlike other types of funds, the members of an SMSF are also its trustees. As a result, they have control over how the savings are invested.
This also means that the members of the SMSF are responsible for complying with the superannuation laws and applicable tax regulations.
An SMSF loan allows members to use their retirement savings to invest in a property by using the SMSF as a deposit. It’s similar to a home loan, except the loan is based on your SMSF contributions. This gives people a chance to buy real estate even if they don’t have cash upfront to do so.
How Does It Work?
SMSF loans for property work differently from a traditional home loan, which makes it a complicated financial product. An SMSF loan for a property is based on the funds in an SMSF. However, several conditions apply in this scenario.
- The property should strictly provide retirement benefits to the members of the SMSF.
- A member or a party related to them cannot reside on the property.
- A member or a party related to them cannot rent the property.
- The property must not be purchased from a party related to the member.
Also, any capital gains or rental income from the property is reinvested into the super fund. Such earnings from the property would only be available after retirement.
These strict conditions apply because the SMSF is strictly designed for retirement benefits. This is why SMSF are also eligible for super fund tax concessions. So any loan against it, or property purchased with it, must also be for retirement purposes.
Violations of these conditions can result in penalties and legal actions. Also, it’s worth mentioning that refinancing an SMSF loan can be a lot more complicated than home loans, and many SMSF lenders may not offer the refinance option.
Why is SMSF Lending Becoming Popular?
Even though the last couple of years have seen global economic downturns and the housing market boom in Australia is slowing down, real estate remains a popular investment area. However, in the case of SMSF loans for property, the growing demand of borrowers can be attributed to the growing rent rates in major Australian cities and even rural areas.
An SMSF loan for a property is not the most convenient option because of the strict conditions and complex processes. However, it allows the self-managed super to be used for a high returns investment.
As SMSF is private and self-managed, unlike a retail or industry super fund, the members of the fund are responsible for managing it and investing it. It can be challenging to invest these funds in lucrative schemes. While many SMSF members invest in shares, real estate is emerging as the next popular trend.
Several factors for this renewed interest in purchasing real estate with SMSF loans exist. Aside from the opportunity of increasing the SMSF fund with rental income and capital gains, the SMSF lenders have also introduced favourable conditions.
Lenders now offer up to 80 per cent loan-to-value ratio (LVR) and a loan term of 30 years, like traditional home loans. Previously, the loan term would be 15 years. As a result, the repayment amounts are down as they are stretched over 30 years instead of 15.
While it’s a complicated product, it has historically shown lower default rates. As a result, non-bank lenders also offer this kind of loan for real estate investment. So for SMSF members, there are more options to choose from.
Commercial properties are the most popular among SMSF loan borrowers, but residential properties are now gaining traction. Again, the rising rents are creating incentives for investors in residential real estate.
Is Buying Property with an SMSF Loan the Right Choice for You?
Managing a super fund on your own is tricky and requires a lot of planning and risk assessment. However, using it to invest in a property may be even more challenging. If done right, it is a solid strategy for using the fund for wealth creation and maximising the retirement benefits of the fund.
The real estate market has been consistently growing for the past decade and even more so in the past two years. It presents the opportunity to use the funds for retirement for high returns in capital gains alone. However, when you factor in rental income, it gets even better.
That said, getting an SMSF loan for a property is a major undertaking, one that requires careful consideration, assessment, and a second opinion. If you’re committed to managing the fund through the end of the loan term and believe you can meet the conditions of the loan while also not violating the general terms of SMSF, it’s a viable investment option.
Unlike a home loan, this property is solely to prepare for retirement, so you cannot live in it until you have paid off the loan. Also, sometimes, lenders may charge higher interest rates than they would for a home loan.
Despite the complexity of an SMSF loan for buying commercial or residential property, SMSF members are seeking out loans to buy real estate. With the real estate market staying strong and lenders offering favourable loan terms, the incentive for SMSF borrowing is high at the moment.
Considering getting an SMSF loan for purchasing a property? Try DDP Property Finance (DDP) Finance to weigh your options. With so many banks and lenders on the table, finding the best option can be confusing. DDP Finance can help you find the best lender and maximise the potential of your retirement funds.